Fiscal Policy: Nature and Significance – Public Revenues – Expenditure- Debt, Development

Activities- Allocation of Funds – Critical Analysis of the Recent Fiscal Policy of Government
of India- Balance of Payments: Nature – Structure – Major Components – Causes for
Disequilibrium in Balance of Payments – Correction Measures.
1. Fiscal Policy: Nature and Significance –
FISCAL POLICY OF INDIA
Fiscal policy is a part of economic policy of the government which is related to government
income and expenditure. It includes public expenditure policy, taxation policy, public debt
policy and deficit financing. It is aimed at achieving certain objectives like – rapid economic
development, reduction in economic inequalities, capital formation, etc.
MEANING OF FISCAL POLICY
Fiscal is related to income and expenditure of government. It refers to budgetary policy of
government. It is also known as income and expenditure policy or tax and expenditure policy
of government. The fiscal policy is of great importance for both developed and developing
countries. It is an instrument fir promoting economic growth, employment, social welfare,
etc.
Fiscal policy is the means by which a government adjusts its spending levels and tax rates to
monitor and influence a nation's economy. It is the sister strategy to monetary policy through
which a central bank influences a nation's money supply.
Objectives of Fiscal Policy in India
1. Ensure development by effective mobilization of resources
The important objective of fiscal policy is to ensure rapid economic growth and development.
This objective of economic growth and development can be achieved by Mobilization of
Financial Resources in right way. The central and the state governments in India have used
fiscal policy to mobilize resources. The financial resources can be mobilized by:-
1. Taxation: Through effective fiscal policies, the government aims to mobilize resources by
way of direct taxes as well as indirect taxes.
2. Public Savings: The resources can be mobilized through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.
3. Private Savings: Through effective fiscal measures such as tax benefits, the government
can raise resources from private sector and households. Resources can be mobilised through
government borrowings by ways of treasury bills, issue of government bonds, etc., loans
from domestic and foreign parties and by deficit financing.
2. Efficient allocation of limited Financial Resources
The central and state governments have tried to make efficient allocation of the available
financial resources. These resources are allocated for Development Activities which includes
expenditure on railways, infrastructure, etc. While Non-development Activities includes
expenditure on defence, interest payments, subsidies, etc. But generally the fiscal policy
should ensure that the resources are allocated for generation of goods and services which are
socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to
encourage production of desirable goods and discourage those goods which are socially
undesirable.
3. Reduction in inequalities of Income and Wealth
Fiscal policy aims at achieving equity or social justice by reducing income inequalities
among different sections of the society. The direct taxes such as income tax are charged more
on the rich people as compared to lower income groups. Indirect taxes are also more in the
case of semi-luxury and luxury items, which are mostly consumed by the upper middle class
and the upper class. The government invests a significant proportion of its tax revenue in the
implementation of Poverty Alleviation Programmes to improve the conditions of poor people
in society.

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4. Price Stability and Control of Inflation
One of the main objectives of fiscal policy is to control inflation and stabilize price. This
requires the measures of monetary Therefore, the government always aims to control the
inflation by reducing fiscal deficits, introducing tax savings schemes, Productive use of
financial resources, etc.
5. Employment Generation
The responsible government is making every possible effort to increase employment in the
country through effective fiscal measure. Investment in infrastructure has resulted in direct
and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units
encourage more investment and consequently generate more employment. Various rural
employment programmes have been undertaken by the Government of India to solve
problems in rural areas. Similarly, self employment scheme is taken to provide employment
to technically qualified persons in the urban areas.
6. Balanced Regional Development
Another main intention of the fiscal policy is to bring about a balanced regional development.
There are various incentives from the government for setting up projects in backward areas
such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at
concessional interest rates, etc.
7. Reducing the Deficit in the Balance of Payment
Fiscal policy tries to encourage exports by way of fiscal measures like Exemption of income
tax on export earnings, Exemption of central excise duties and customs, Exemption of sales
tax and octroi, etc. The foreign exchange is also protected by providing fiscal benefits to
import substitute industries, imposing customs duties on imports, etc. The foreign exchange
earned by way of exports and saved by way of import substitutes helps to solve balance of
payments problem. In this way adverse balance of payment can be corrected either by
imposing duties on imports or by giving subsidies to export.
There are three sources from where the government gets money. The first two are revenue
sources, and the last one is borrowings and capital asset sales.
1. Revenue Receipts or Tax Revenue: This is the tax that the government collects in the
form of corporation tax, personal income tax, customs, excise etc.
2. Non Tax Revenue: These include interests on bonds held, dividends from PSUs, and
grants.
They are revenue sources meaning they don't have to be repaid and are smaller than tax
revenues.
3. Capital Receipts: These are borrowings of the government like the market loans, short
term borrowings, external commercial receipts etc.
COMPON ENTS OF FISCAL POLICY
Taxation policy Public expend it ure policy Deficit financing Public debt policy
1. PUBLIC EXPENDITURE POLICY MAIN features of government policy regarding
public expenditure are as follows:-
1. Development of public enterprise: Underdeveloped countries lack in basic and heavy
industries. Establishment of these industries requires huge capital investment.
2. Support to private sector: In order to accelerate the rate of economic growth in the country,
government should encourage private sector.
3. Development of infrastructure: government should spent huge amount for development of
infrastructure
4. Social welfare: government should spend huge amount on public health education, safe
drinking water, sanitation.

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 2. TAXATION POLICY Taxes are the main source of revenue of government. Government
levies on both direct and indirect taxes in India. Main objectives of taxation policy are as
follows:
1. Mobilization of resources: taxes are the major sources of government revenue. Tax
revenue in India has been rising every year.
2. To promote saving: one of the important objectives of taxation policy is to promote
savings. For this purpose various tax concessions, tax deductions are given.
3. To promote investment: to promote investment in remote and backward areas, tax
concessions are given.
4. To bring equality of income and wealth: to achieve this objective different kinds of direct
taxes are levied.
3. PUBLIC DEBT POLICY Public debt is obtained from two kinds of sources:
1. Internal debt: internal debt should be mobilized that it has no adverse effect on private
investment.
2. External debt: India cannot meet its financial requirements from internal debt alone .it has
to borrow from abroad as well.
4. DEFICIT FINANCING In western sense, deficit financing refers to printing of new
currency notes to fill gap between revenue and expenditure i.e. budgetary deficit. IN Indian
sense, deficit financing refers to the loans taken from the Reserve Bank of India to cover the
deficit in the budget. The RBI provides this loan by creating new currency and reducing govt.
cash balances. The new currency increases the money supply leading to increase in the size of
aggregate demand.
Importance of Fiscal Policy
1. Government activities are enlarged.
2. Tax –Revenue and expenditure accounts for large proportion GNP.
3. Government affects the economic activities through gap between government receipts and
borrowings.
4. It indicates the level of overall borrowings by the government.
5. It is the indicator of fiscal health of the economy.
TYPES OF FISCAL POLICY: The various types of fiscal policy are as follows:-
1. Discretionary Fiscal Policy Contractionary fiscal policy Expansionary fiscal policy
2.Compensatory Fiscal Policy
3. Automatic Stabilization Fiscal Policy
4. Functional fiscal Policy
1. DISCRETIONARY FISCAL POLICY:- In this policy the government makes deliberate
changes in the level and pattern of taxation, size and pattern of its expenditure and the size
and composition of public debt. Policy can either be contractionary or expansionary.
A. Contractionary fiscal policy:- when the govt. reduces its expenditure and increase the
taxation rate, it is known as contractionary fiscal policy. This happens during inflation in
order to control the supply of money And to reduce purchasing power.
B. Expansionary fiscal policy: - the fiscal policy is expansionary in nature, when the
government increases its expenditure and decreases the tax rate. This policy is followed
during the periods of deflation.
2. COMPENSATOEY FISCAL POLICY:- The compensatory fiscal policy is a deliberate
action taken by the government to compensate for deficiency in supply or excess of aggregate
demand. In this process the government increases the tax rates and decreases the govt.
expenditure. This type of policy will lower the aggregate demand and inflation will be
reduced.
3. AUTOMATIC STABILIZATION FISCAL POLICY:- Automatic fiscal policy means
adopting a fiscal system with built in flexibility of tax revenue and government spending.

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4. FUNCTIONAL FISCAL POLICY:- The concept of functional finance is much used in
the developed capitalist countries of the west. According to learner, the fiscal policy should
be used to bring economic stabilization in the economy. So, fiscal policy should be contra
cyclical in nature. It means policy of deficit budget (when expenditure is greater than
revenue) is adopted during depression and the policy of surplus budget(when revenue is
greater than expenditure) is adopted during inflation.
ADVANTAGES OF FISCAL POLICY
1. Capital formation: fiscal policy has played a significant role in the capital formation of
public and private sectors. It leads to economic development of the nation.
2. Inducement to private sector: fiscal policy of India has provided incentives to private
sector for investment and production by several measures.
3. Mobilization of resources: fiscal policy has also helped mobilization of resources. To
execute the plan, resources have mainly been provided by internal resources.
4. Incentives for saving: fiscal policy has provided several incentives for savings to household
and corporate sectors. To encourage savings in the household sectors several tax concessions
are provided.
5. Development of Public Enterprises: Fiscal policy has been providing finance for
development of public enterprises. These public enterprises have been set up in the area of
basic and heavy industries.
6. Social Welfare: Through fiscal policy government spends huge amount on public health,
education, safe drinking water, welfare of weaker sections of society, child welfare, woman
welfare, welfare of aged persons, etc.
7. Alleviation of Poverty and Generation of employment Opportunities: Fiscal policy has
been endeavoring to alleviate poverty. With a view of providing employment to the poor
people of the country and to enhancing their level of income, considerable public expenditure
was incurred on several programmers initiated in this respect
8. A tool to control recession: fiscal policy is a significant tool to counter the negative impact
of economic recession. In the year 2012-2013 and 2013- 2014, fiscal policy is deficit was 4.9
percent and 4.6 percent of GDP respectively. Such fiscal measures have promoted demand
and thereby production.
Disadvantages or limitations
1.Weak Policy Making Machinery:- fiscal policy has to solve lot of problems in the under
developed countries where policy making machinery is weak and the implementation of
particular type of fiscal policy takes a very long time.
2. Political Factors:- in India all economic decisions taken by the govt. are influenced by the
political factors. Major proportion of economic decisions taken by the govt. regarding
revenue and expenditure of the govt. are influenced by the vote bank rather by the economic
rationality.
3. Defective Tax Structure: In India share of direct taxes is less than the share of indirect
taxes. Such tax structure proves burdensome for the poor.
4. Failure Of Public Sector: Various public sector units are running at losses. Huge
investment in public enterprises has failed to generate adequate return on this investment.
Some public sector undertakings have failed to pay even interest on the capital invested
therein.
5. Increasing Interest Burden: under fiscal policy government has taken huge public debt
both from internal and external sources. This has resulted into undue interest burden on
government exchequer.
6.Increase In Non-Development Expenditure: In fiscal policy government is spending huge
amount on non- development expenses like- defiance expenses, election expenses, subsidies,
foreign travels, interest payments, grants to states/UTs, etc. These expenses are of

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 unproductive nature and put undue burden on government exchequer. Fiscal policy has failed
to control non- development expenditure.
7. Inelastic: - although fiscal policy is considered as an important instrument in the hands of
the government used to manage its revenue and expenditure. The critics are of view that it is
not an easy to manipulate the fiscal instruments as desired. A simple modification in the
fiscal instrument may require modifications in certain other economic instruments also. So
this become the shortcoming of fiscal policy.
8. Problems Of Statistical Data: - it is an established fact that implications of a decision
largely depends upon the quality of the decision, while the quality of decision is ultimately
depends upon the quality of information available to make decisions. There may be problem
of data available which becomes the limitation of fiscal policy.
2. Public Revenues – Expenditure-
PUBLIC REVENUE
Government needs to perform various Functions in the field of political, social and economic
activities to maximize social and economic welfare. In order to perform these duties and
functions government require large amount of resources. These resources are called Public
Revenues.
The term Public Revenue can be used in two senses
1. Narrow sense- it includes only those sources of income of the government which are
described as revenue resources. These sources are not subject to repayment. Eg:- tax, fee,
fines etc.
2. Widersense–itincludes all the income and receipts of the government irrespective of their
sources.Eg:-loans rose by the government which is to be repaid.
In aggregate public income or the public revenue is the income of the government through all
the sources.
CLASSIFICATIONS OF PUBLIC REVENUE
1. Adam Smith’s Classification
A. Revenue From The People
B. Revenue From The State Property
C. Revenue From The People Includes Tax Revenue.
D. Revenue from The State Includes Revenue From The Public Enterprises.
2. Bastable’s Classification
• Revenue Received By the Government through Various State Functions.
• Revenue Received By the State By its Own Capacity
 Various Functions Include fee and Prices (Administrative Revenue).
 Revenue Earned By State’s own Capacity includes the revenue received by imposing tax
(Tax Revenue).
3. Prof. Adam’s Classification
Direct Revenue- Derivative Revenue- Anticipatory Revenue
A. Direct Revenue: This category includes all the income which the state derives from
public enterprises like Rail, Road, and Post & Telegraph etc.
B.Derivative Revenue: The Income Derived from the Public is Grouped under This Category.
Example: Taxes, Fees, Fines Penalties etc.
C.Anticipatory Revenue: It includes income from the sale of bond or other forms of
commercial revenue.
4. Seligman’s Classification
□ Gratuitous Revenue- Contractual Revenue-Compulsory Revenue
• Gratuitous Revenue: it is revenue which is received by the state without any cost. Example:
Gifts

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• Contractual Revenue: it is revenue received by the state as a result of the sale of commodities
and services by the government to the people.
• Compulsory Revenue: compulsory revenue are those revenues which are derived by the
government in the form of tax, fee, fine etc.
5. Dalton’s Classification
 Tax
 Price
Tax: Tax is a compulsory charge imposed by public authority.
Price: Prices are paid voluntarily by private persons, who enters into contracts with
authorities.
6. Ideal Classification
Prof. Findlay Shirras Classifies Public Income into Two Categories
 Tax Revenue
 Non – Tax Revenue
Tax Revenue: Revenue Earned By the State by imposing tax.
Non – Tax Revenue:Revenue earned by the state from other than the tax source.
7. Taylor’s Classification
• Gifts and Grants-Administrative Revenue-Commercial Revenues-Taxes
Gifts and Grants: Grant – Financial assistance provided by one government to another.
Example: central Government may provide Grant-in-Aid to State governments to perform
some functions.
Administrative Revenue: Revenue received by the state by performing administrative
functions. Example: Fees, Fine, Penalty etc.
Commercial Revenue: commercial revenues received by the government in the form of prices
paid for government produced goods and services. Example: Tuition fee paid in Public
Education institutions.
Taxes: Taxes are the compulsory payments to government without any exceptions.
Taylor’s Classifications of public revenue is most logical and scientific and seems to be quite
useful from the practical point of view.
8. Prof. J K Mehta’s Classification
● Tax- Fee- Duty
Tax: when the object is to obtain money for the finance of services (production of goods
included), the levy should be regarded as tax.
Fee:a levy, which has the object of discouraging the consumption of goods and services
performed by the state has been called as fee.
Duty :if the object is to discourage the production or the use of commodities produced by
private agencies or functions performed by such agencies, the levy has been called as Duty.
Sources of Public Revenue
The sources by which a government earns its income are classified into two categories.
a. Tax Revenue
b. Non Tax revenue
Tax revenue is the income that is gained by governments through taxation. Taxes are
compulsory contribution levied by the state for meeting expenses in the common interests of
all citizens. Tax revenue can be classified into:
(1) Direct taxes and
(2) Indirect taxes.
Direct Taxes: A tax is said to be direct, if the tax payer bears the burden of the tax. He
cannot shift the burden to any other person. Example – Income tax, wealth tax and gift tax.

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Indirect Taxes: Indirect tax is shifted by the payer to others. If sales tax is imposed on sugar,
the producer or dealer who pays it passes it on to the next buyer and ultimately the burden is
borne by the consumer. Example- Sales tax
Non-Tax Revenue
Non-Tax Revenue sources of public revenue which are raised by the government from other
than tax in the economy.
ADMINISTRATIVE REVENUES
1. Fees: Fees is a payment charged by the government to bear the cost of administrative
services rendered in public services. A fee is not a voluntary payment it is a compulsory
payment.
2. Special Assessments “A compulsory Contribution, levied in proportion to the special
benefit derived to defray the cost of special improvement to property undertaken in the public
interest.”Example - by the construction of roads, schools etc are going to yield some common
benefit to the society. Because of this the values or the rent of the property may increase.So
that the government can impose some levy on these special assessments to recover a part of
expenses incurred.
3. Fines and Penalties: These are not an important source of public revenue. Fine -
punishment imposed for infringement of law.
4. Forfeitures: It refers to the penalty imposed by courts for the failure of individuals to
appear in the court.Forfeitures is also not important source of public revenue.
5. Escheats: Escheats are the claims of the government to the property of a person who dies
without having any legal heirs or without keeping a will. In such situations all the property of
the person including bank balance and other properties pass to the government.
Public expenditure
Public expenditure is spending made by the government of a country on collective needs and
wants such as pension, provision, infrastructure, etc. Until the 19th century, public
expenditure was limited as laissez faire philosophies believed that money left in private hands
could bring better returns. In the 20th century, John Maynard Keynes argued the role of
public expenditure in determining levels of income and distribution in the economy. Since
then government expenditures has shown an increasing trend.
In the 17th and the 18th centuries public expenditure was considered as wastage of money.
Thinkers said government should stay with their traditional functions of spending on defence
and maintaining law and order.

Several theories of taxation exist in public economics. Governments at all levels (national,
regional and local) need to raise revenue from a variety of sources to finance public-sector
expenditures. The details of taxation are guided by two principles: who will benefit, and who
can pay. Public expenditure means the expenditure on the developmental and non-
developmental activity such as construction of roadways and dams, and other activity.
Dalton’s principle of maximum social advantage. Graph showing point of maximum social
advantage at point “P”
Principle of maximum social advantage
The criteria and pre-conditions for arriving at this solution are collectively referred to as the
principle of maximum social advantage. Taxation (government revenue) and
government expenditure are the two tools. Neither of excess is good for the society, it has to
be balanced to achieve maximum social benefit. Dalton called this principle as “Maximum
Social Advantage” and Pigou termed it as “Maximum Aggregate Welfare”.
Dalton’s Principle of Maximum Social Advantage – maximum satisfaction should be yield
by striking a balance between public revenue and expenditure by the government. Economic

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 welfare is achieved when marginal utility of expenditure = marginal disutility of taxation. He
explains this principle with reference to
 Maximum Social Benefit (MSB)
 Maximum Social Sacrifice (MSS)
It was introduced by Swedish Economist “Erik Lindahl in 1919”.[4] According to his theory,
determination of public expenditure and taxation will happen on the basis of public
preferences which they will reveal themselves. Cost of supplying a good will be taken up by
the people. The tax that they will pay will be revealed by them according to their capacities.

Causes of growth of public expenditure

There are several factors that have led to enormous increase in public expenditure through the
years
1) Defence expenditure due to modernization of defence equipment by navy, army and air
force to prepare the country for war or for prevention causes-for-growth-of-public-
expenditure.
2) Population growth – It increases with the increase in population, more of investment is
required to be done by government on law and order, education, infrastructure, etc.
investment in different fields depending on the different age group is required.
3) Welfare activities – welfare, mid-day meals, pension provisions etc.
 Provision of public and utility services – provision of basic public goods given by
government (their maintenance and installation) such as transportation.
 Accelerating economic growth – in order to raise the standard of living of the people.
 Price rise – higher price level compels government to spend increased amount on purchase of
goods and services.
 Increase in public revenue – with rise in public revenue government is bound to increase the
public expenditure.
 International obligation – maintenance of socio economic obligation, cultural exchange etc.
(these are indirect expenses of government)
4) Wars and social crises – fighting amongst people and communities, and prolonged drought
or unemployment, earthquake, hurricanes or tornadoes may lead to increase in public
expenditure of a country. This is because it will involve governments to re-plan and allocate
resources to finance the reconstruction.
5) Creation of super national organizations – E.g., the United Nations, NATO, European
community and other multinational organizations that are responsible for the provision of
public goods and services on an international basis, have to be financed out of funds
subscribed by member states, thereby adding to their public expenditure.

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 6) Foreign aid – Acceptance by the richer industrialised countries of their responsibility to
help the poor developing countries has channeled some of the increased public expenditure of
the donor country into foreign aid programmes.
7) Inflation – This is the general rise in price level of goods and services. It increases the cost
of all activities of the public sector and thus a major factor in growth in money terms of
public expenditure.
3. Debt, Development Activities-
Modern governments need to borrow from different sources when current revenue falls short
of public expenditures. Thus, public debt refers to loans incurred by the government to
finance its activities when other sources of public income fail to meet the requirements. In
this wider sense, the proceeds of such public borrowing constitute public income.
However, since debt has to be repaid along with interest from whom it is borrowed, it does
not constitute income. Rather, it constitutes public expenditure. Public debt is incurred when
the government floats loans and borrows either internally or externally from banks,
individuals or countries or international loan-giving institutions.
What is true about public borrowing is that, like taxes, public borrowing is not a compulsory
source of public income. The word ‘compulsion’ is not applied to public borrowing except in
certain exceptional cases of borrowing.
Classification of Public Debt:
The structure of public debt is not uniform in any country on account of factors such as
categories of markets in which loans are floated, the conditions for repayment, the rate of
interest offered on bonds, purposes of borrowing, etc.
In view of these differences in criteria, public debt is classified into various categories:
i. Internal and external debt
ii. Short term and long term loans
iii. Funded and unfunded debt
iv. Voluntary and compulsory loans
v. Redeemable and irredeemable debt
vi. Productive or reproductive and unproductive debt/deadweight debt
i. Internal and External Debt:
Sums owed to the citizens and institutions are called internal debt and sums owed to
foreigners comprise the external debt. Internal debt refers to the government loans floated in
the capital markets within the country. Such debt is subscribed by individuals and institutions
of the country.
On the other hand, if a public loan is floated in the foreign capital markets, i.e., outside the
country, by the government from foreign nationals, foreign governments, international
financial institutions, it is called external debt.
ii. Short term and Long Term Loans:
Loans are classified according to the duration of loans taken. Most government debt is held in
short term interest-bearing securities, such as Treasury Bills or Ways and Means Advances
(WMA). Maturity period of Treasury bill is usually 90 days.
Government borrows money for such period from the central bank of the country to cover
temporary deficits in the budget. Only for long term loans, government comes to the public.
For development purposes, long period loans are raised by the government usually for a
period exceeding five years or more.
iii. Funded and Unfunded or Floating Debt:
Funded debt is the loan repayable after a long period of time, usually more than a year. Thus,
funded debt is long term debt. Further, since for the repayment of such debt government
maintains a separate fund, the debt is called funded debt. Floating or unfunded loans are those
which are repayable within a short period, usually less than a year.

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It is unfunded because no separate fund is maintained by the government for the debt
repayment. Since repayment of unfunded debt is made out of public revenue, it is referred to
as a floating debt. Thus, unfunded debt is a short term debt.
iv. Voluntary and Compulsory Loans:
A democratic government raises loans for the nationals on a voluntary basis. Thus, loans
given to the government by the people on their own will and ability are called voluntary
loans. Normally, public debt, by nature, is voluntary. But during emergencies (e.g., war,
natural calamities, etc.,) government may force the nationals to lend it. Such loans are called
forced or compulsory loans.
v. Redeemable and Irredeemable Debt:
Redeemable public debt refers to that debt which the government promises to pay off at some
future date. After the maturity period, the government pays the amount to the lenders. Thus,
redeemable loans are called terminable loans.
In the case of irredeemable debt, government does not make any promise about the payment
of the principal amount, although interest is paid regularly to the lenders. For the most
obvious reasons, redeemable public debt is preferred. If irredeemable loans are taken by the
government, the society will have to face the consequence of burden of perpetual debt.
vi. Productive (or Reproductive) and Unproductive (or Deadweight) Debt:
On the criteria of purposes of loans, public debt may be classified as productive or
reproductive and unproductive or deadweight debt. Public debt is productive when it is used
in income-earning enterprises. Or productive debt refers to that loan which is raised by the
government for increasing the productive power of the economy.
A productive debt creates sufficient assets by which it is eventually repaid. If loans taken by
the government are spent on the building of railways, development of mines and industries,
irrigation works, education, etc., income of the government will increase ultimately.
Productive loans thus add to the total productive capacity of the country.
In the words of Findlay Shirras: “Productive or reproductive loans which are fully
covered by assets of equal or greater value, the source of the interest is the income from
the ownership of these as railways and irrigation works.”
Public debt is unproductive when it is spent on purposes which do not yield any income to
the government, e.g., refugee rehabilitation or famine relief work. Loans for financing war
may be regarded as unproductive loans. Instead of creating any productive assets in the
economy, unproductive loans do not add to the productive capacity of the economy. That is
why unproductive debts are called deadweight debts.
Methods of Redemption of Public Debt:
Redemption of debt refers to the repayment of a public loan. Although public debt should be
paid, debt redemption is desirable too. In order to save the government from bankruptcy and
to raise the confidence of lenders, the government has to redeem its debts from time to time.
Sometimes, the government may resort to an extreme step, such as repudiation of debt. This
extreme step is, of course, violation of the contract. Use of repudiation of debt by the
government is economically unsound.
Here, instead of concentrating on the repudiation of debt, we discuss below other
important methods for the retirement or redemption of public debt:
i. Refunding:
Refunding of debt implies issue of new bonds and securities for raising new loans in order to
pay off the matured loans (i.e., old debts).
When the government uses this method of refunding, there is no liquidation of the money
burden of public debt. Instead, the debt servicing (i.e., repayment of the interest along with
the principal) burden gets accumulated on account of postponement of the debt- repayment to
save future debt.

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ii. Conversion:
By debt conversion we mean reduction of interest burden by converting old but high interest-
bearing loans into new but low interest-bearing loans. This method tends to reduce the burden
of interest on the taxpayers. As the government is enabled to reduce the burden of debt which
falls, it is not required to raise huge revenue through taxes to service the debt.
Instead, the government can cut down the tax liability and provide relief to the taxpayers in
the event of a reduction in the rate of interest payable on public debt. It is assumed that since
most taxpayers are poor people while lenders are rich people, such conversion of public debt
results in a less unequal distribution of income.
iii. Sinking Fund:
One of the best methods of redemption of public debt is sinking fund. It is the fund into
which certain portion of revenue is put every year in such a way that it would be sufficient to
pay off the debt from the fund at the time of maturity. In general, there are, in fact, two ways
of crediting a portion of revenue to this fund.
The usual procedure is to deposit a certain (fixed) percentage of its annual income to the
fund. Another procedure is to raise a new loan and credit the proceeds to the sinking fund.
However, there are some reservations against the second method.
Dalton has opined that it is in the Tightness of things to accumulate sinking fund out of the
current revenue of the government, not out of new loans. Although convenient, it is one of
the slowest methods of redemption of debt. That is why capital levy as a form of debt
repudiation is often recommended by economists.
iv. Capital Levy:
In times of war or emergencies, most governments follow the practice of raising money
necessary for the redemption of the public debt by imposing a special tax on capital.
A capital levy is just like a wealth tax in as much as it is imposed on capital assets. This
method has certain decisive advantages. Firstly, it enables a government to repay its
(emergency) debt by collecting additional tax revenues from the rich people (i.e., people who
have huge properties).
This then reduces consumption spending of these people and the severity of inflation is
weakened. Secondly, progressive levy on capital helps to reduce inequalities in income and
wealth. But it has certain clear-cut disadvantages too. Firstly, it hampers capital formation.
Secondly, during normal time this method is not suggested.
v. Terminal Annuity:
It is something similar to sinking fund. Under this method, the government pays off its debt
on the basis of terminal annuity. By using this method, the government pays off the debt in
equal annual installments.
This method enables government to reduce the burden of debt annually and at the time of
maturity it is fully paid off. It is the method of redeeming debts in installments since the
government is not required to make one huge lump sum payment.
vi. Budget Surplus:
By making a surplus budget, the government can pay off its debt to the people. As a general
rule, the government makes use of the budgetary surplus to buy back from the market its own
bonds and securities. This method is of little use since modern governments resort to deficit
budget. A surplus budget is usually not made.
vii. Additional Taxation:
Sometimes, the government imposes additional taxes on people to pay interest on public debt.
By levying new taxes—both direct and indirect— the government can collect the necessary
revenue so as to be able to pay off its old debt. Although an easier means of repudiation, this
method has certain advantages since taxes have large distortionary effects.
viii. Compulsory Reduction in the Rate of Interest:

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 The government may pass an ordinance to reduce the rate of interest payable on its debt. This
happens when the government suffers from financial crisis and when there is a huge deficit in
its budget.
There are so many instances of such statutory reductions in the rate of interest. However,
such practice is not followed under normal situations. Instead, the government is forced to
adopt this method of debt repayment when situation so demands.
4. Allocation of Funds –
There are two types of goods in an economy – private goods and public goods. Private goods
have a kind of exclusivity to themselves. Only those who pay for these goods can get the
benefit of such goods, for example – a car. In contrast, public goods are non-exclusive.
Everyone, regardless of paying or not, can benefit from public goods, for example – a road.
The allocation function deals with the allocation of such public goods. The government has to
perform various functions such as maintaining law and order, defense against foreign attacks,
providing healthcare and education, building infrastructure, etc. The list is endless. The
performance of these functions requires large scale expenditure, and it is important to allocate
the expenditure efficiently. The allocation function studies how to allocate public expenditure
most efficiently to reap maximum benefits with the available public wealth.
 Some forms of government expenditure are specifically intended to transfer income from
some groups to others. For example, governments sometimes transfer income to people that
have suffered a loss due to natural disaster. Likewise, public pension programs transfer
wealth from the young to the old. Other forms of government expenditure that represent
purchases of goods and services also have the effect of changing the income distribution. For
example, engaging in a war may transfer wealth to certain sectors of society. Public
education transfers wealth to families with children in these schools. Public road
construction transfers wealth from people that do not use the roads to those people that do
(and to those that build the roads).
 Income Security
 Employment insurance
 Health Care
 Public financing of campaigns
The Union Budget for 2019-20 was announced by Ms Nirmala Sitharaman, Minister for
Finance and Corporate Affairs, Government of India, in Parliament on July 05, 2019. India is
all set to become US$ 3 trillion economy by the end of FY20. The budget focusses on
reducing red tape, making best use of technology, building social infrastructure, digital India,
pollution free India, make in India, job creation in Micro, Small and Medium Enterprises
(MSMEs) and investing heavily in infrastructure.
Total expenditure for 2019-20 is budgeted at Rs 2,786,349 crore (US$ 417.95 billion), an
increase of 14.09 per cent from 2018-19 (budget estimates).
5. Critical Analysis of the Recent Fiscal Policy of Government of India-
1. Expenditure: The government proposes to spend Rs 27,86,349 crore in 2019-20, which is
13.4% above the revised estimate of 2018-19.
2. Receipts: The receipts (other than net borrowings) are expected to increase by 14.2% to Rs
20,82,589 crore, owing to higher estimated revenue from corporation tax and dividends.
3. GDP growth: The government has assumed a nominal GDP growth rate of 12% (i.e., real
growth plus inflation) in 2019-20. The nominal growth estimate for 2018-19 was 11.5%.
4. Deficits: Revenue deficit is targeted at 2.3% of GDP, which is higher than the revised
estimate of 2.2% in 2018-19. Fiscal deficit is targeted at 3.3% of GDP, lower than the revised
estimate of 3.4% in 2018-19. Note that the government is estimated to breach its budgeted
target for fiscal deficit (3.3%) in 2018-19 and the medium term fiscal target of 3.1% in 2019-
20.

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5. Ministry allocations: Among the top 13 ministries with the highest allocations, the highest
percentage increase is observed in the Ministry of Agriculture and Farmers’ Welfare (82.9%),
followed by Ministry of Petroleum and Natural Gas (32.1%) and Ministry of Railways
(23.4%).
Tax proposals in the Finance Bill
In addition to changes in tax laws, the Finance Bill, 2019 proposes changes in several other
laws such as the SEBI Act, The RBI Act, the CGST Act, and the PMLA Act.
1. Surcharge on income tax: Currently, a surcharge of 15% is levied on the income of
individuals earning over one crore rupees, and 10% on income of individuals earning
between Rs 50 lakh and one crore rupees. In the Union Budget 2019-20, the surcharge on
income tax for individuals earning between two crore rupees and five crore rupees has been
increased to 25% and for persons earning over five crore rupees has been increased to 37%.
2. Corporation tax: Currently, companies with annual turnover of less than Rs 250 crore pay
corporate income tax at the rate of 25%. This threshold has been increased to Rs 400 crore.
3. Tax on cash withdrawals: A TDS of 2% will be levied by financial companies and post
offices on individuals for cash withdrawals exceeding one crore rupees in a year from a bank
account.
4. Tax exemption for affordable housing: An additional tax deduction of up to Rs 1,50,000
will be provided on interest paid on loans for self-occupied house owners. The conditions for
availing this deduction are: (i) the loan must be sanctioned in FY 2019-20, (ii) the stamp duty
on the house should not exceed Rs 45 lakh rupees, and (iii) the individual should not own
another residential house property as of the date of the home loan.
5. Tax exemptions for electric vehicles: A tax deduction of up to Rs 1,50,000 will be provided
on interest paid on loans to purchase an electric vehicle. This deduction will be applicable for
loans sanctioned between FY 2019-20 and FY 2022-23.
6. Road and infrastructure cess: The Road and Infrastructure Cess on petrol and high-speed
diesel has been increased by one rupee per litre. Excise duty has also been increased by one
rupee per litre for these products.
7. Customs duty: The customs duty on gold and precious metals will be increased from 10% to
12.5%.
Policy Highlights
1. Banking and Finance: The government plans to partially guarantee (for first 10% of loss)
Public Sector Banks for funds provided in a pooled manner to NBFCs. Further, Rs 70,000
crore will be provided for recapitalisation of Public Sector Banks.
2. Government borrowings: Currently, the gross borrowing programme of the government is
funded entirely through domestic borrowings. The government plans to raise a part of its
borrowings abroad in foreign currency.
3. Infrastructure: The central government will invest Rs 100 lakh crore in infrastructure over
the next five years. Phase II of the Bharatmala project will be launched under which state
highways will be developed. Public private partnerships will be leveraged for railways to
attract an investment of Rs 50 lakh crore during the period 2018-30. A blue print will be
made for developing gas-grids, water-grids, i-ways (communication networks) and regional
airports on the lines of the One Nation–One Grid for power. Structural reforms in the power
sector (including tariff) will be announced.
4. Industry: The minimum public shareholding in listed companies will be increased from 25%
to 35%. A new electronic fund raising platform will be created for listing social enterprises
and voluntary organisations. The present policy of 51% stake of government in non-financial
PSUs will be modified to include stake of government controlled institutions.
5. Investments: 100% Foreign Direct Investment (FDI) will be permitted for insurance
intermediaries. Local sourcing norms will be eased for FDI in the single brand retail sector.

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 Further, relaxing of the FDI norms in aviation, media and insurance sectors will be examined.
Statutory limit for Foreign Portfolio Investment will be increased from the current 24% to
sectoral limits. Foreign shareholding limits in PSUs will be increased to the maximum
permissible sectoral limit.
6. Agriculture and allied activities: Pradhan Mantri Matsya Sampada Yojana has been
proposed to address infrastructure gaps in the fisheries sector. 10,000 new Farmer Producer
Organisations will be setup over the next five years. The central government will work
towards adoption of zero-budget farming.
7. Rural Development: Under the Pradhan Mantri Gram Sadak Yojana, 1.25 lakh km of road
will be upgraded at an estimated cost of Rs 80,250 crore in the next five years. 100 new
clusters will be setup under the Scheme of Fund for Upgradation and Regeneration of
Traditional Industries (SFURTI). All rural households will be provided with piped water
supply by 2024 under the Jal Jeevan Mission. Swachh Bharat Mission will be expanded to
undertake solid waste management in every village.
8. Social Justice: An overdraft of Rs 5,000 will be provided to women self-help group (SHG)
members who hold Jan-Dhan accounts. Further, a loan up to one lakh rupees will be provided
under the MUDRA scheme to one woman in every SHG.
9. Social Security: A new pension benefit scheme, namely Pradhan Mantri Karam Yogi
Maandhan Scheme, has been announced for traders and small shopkeepers with annual
turnover of less than Rs 1.5 crore.
10. Education: The new National Education Policy will be introduced. The National Research
Foundation will be setup to promote funding and coordinate research in the country. A Study
in India programme will be launched to encourage foreign students in higher education.
11. Legislative Framework: To promote rental housing, a model tenancy law will be finalised
and circulated. The Higher Education Commission of India Bill will be introduced. Different
multiple labour laws will be streamlined into a set of four labour codes.
Budget estimates of 2019-20 as compared to revised estimates of 2018-19
1. Total Expenditure: The government is estimated to spend Rs 27,86,349 crore during 2019-
20. This is 13.4% more the revised estimate of 2018-19. Out of the total expenditure, revenue
expenditure is estimated to be Rs 24,47,780 crore (14.3% growth) and capital expenditure is
estimated to be Rs 3,38,569 crore (6.9% growth).
2. Total Receipts: The government receipts (excluding borrowings) are estimated to be Rs
20,82,589 crore, an increase of 14.2% over the revised estimates of 2018-19. The gap
between these receipts and the expenditure will be plugged by borrowings, budgeted to be Rs
7,03,760 crore, an increase of 10.9% over the revised estimate of 2018-19.
3. Transfer to states: The central government will transfer Rs 13,29,428 crore to states and
union territories in 2019-20. This is an increase of 6.6% over the revised estimates of 2018-
19 and includes devolution of (i) Rs 8,09,133 crore to states, out of the centre’s share of
taxes, and (ii) Rs 5,20,295 crore in the form of grants and loans.
4. Deficits: Revenue deficit is targeted at 2.3% of GDP, and fiscal deficit is targeted at 3.3% of
GDP in 2019-20. The target for primary deficit (which is fiscal deficit excluding interest
payments) is 0.2% of GDP.
5. GDP growth estimate: The nominal GDP is estimated to grow at a rate of 12% in 2019-20.
The estimated nominal GDP growth rate for 2018-19 is 11.5%
6. Balance of Payments: Balance of payments (BOP) accounts are an accounting record of all
monetary transactions between a country and the rest of the world. These transactions include
payments for the country's exports and imports of goods & services, financial capital, and
financial transfers.
A country has to deal with other countries in respect of 3 items:-
• Visible items which include all types of physical goods exported and imported.

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• Invisible items which include all those services whose export and import are not visible. e.g.
transport services, medical services etc.
• Capital transfers which are concerned with capital receipts and capital payment.
Definition-According to Kindle Berger, "The balance of payments of a country is a
systematic record of all economic transactions between the residents of the reporting country
and residents of foreign countries during a given period of time".
6. Nature –
1. It is a statement having two sides.
2. It is a record of economic transaction. It shows a relation between receipts & payments.
3. Visible & Invisible items both are included in this statement.
4. It is prepared for a certain period of time.
Structure
• The Balance of Payments of a country is mainly divided into two types of accounts – (1)
Current Account
• (2) Capital Account.
Major Components –
(1) Current Account – The current account of a country’s balance of payments consists of
all transactions related to trade in goods, services, income and unilateral transfers . The
current account includes following items -50
(a) Merchandise Exports & Imports – Merchandise exports and imports are the most important
items in the current account. In general, it covers a significant portion of total transactions
recorded in the BOP of a country. Generally, exports are calculated on free on board (f.o.b.)
basis which means that the costs of transportation, insurance, etc. are excluded. Generally,
imports are calculated on carriage, insurance and freight (c.i.f.) basis which means that costs
of transportation, insurance and freight are included.
(b) Invisible Exports & Imports - Invisible exports & imports also known as service exports &
imports are another important component of current account. Important invisible items would
include – travel, insurance, transportation, investment income in the form of profits,
dividends, etc. and Government not included elsewhere.(g.n.i.e)
(c) Unilateral Transfers – Unilateral transfers or transfer payments are the third important
component of current account. Unilateral transfers include gifts, grants, etc. either received
from abroad (credits) or given abroad. (debits). They are one sided transactions, without a
quid pro quo that has a measurable value. The unilateral transfers could be official or private.
(2) Capital Account - The capital account of a country consists of its transactions in
financial assets in the form of short term and long term lending and borrowing and private
and official investments. In other words, the capital account shows international flow of loans
and investments, and represents a change in the country’s foreign assets and liabilities. The
capital account mainly consists of –
a) Borrowing from & Lending to Foreign Countries – Borrowing from foreign countries are
credit entries because they are receipts from foreign countries. Lending to foreign countries
are debit entries because they are payments to foreign countries. This borrowing or lending
could be of short term i.e. up to one year or long term i.e. more than one year. Borrowing
from & lending to foreign countries could be also called as net sale of assets to foreigners and
net purchases of assets from foreigners.
b) Direct Investment & Portfolio Investment – Direct investment is investment in enterprises
located in one country but effectively controlled by residents of another country. As a rule,
direct investment takes the form of investment in branches and subsidiaries by parent
companies located in another country. Portfolio investment refers to purchases of foreign
securities that do not carry any claim on control or ownership of foreign enterprises. In brief,
borrowing from foreign countries and direct & portfolio investment by foreign countries

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 represent capital inflows. On the other hand, lending to foreign countries and direct &
portfolio investment in foreign countries represent capital outflows.
In broader terms, real or income creating transactions are entered into current account of
BOP, while financial or capital transactions are entered into capital account of BOP. Lindert
(2002) remarks that “ Balance –of –payments accounting is unique in that it shows all the real
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and financial flows between a country and the rest of the world.”
(3)Other Components - Apart from the above two main accounts, BOP of a country also
includes some other entries like – (a) Transactions with IMF, (b) SDR allocations, (c) Errors
& Omissions and (d) Official settlements / Reserve account.
7. Causes for Disequilibrium in Balance of Payments –
1. Natural causes – e.g. floods, earthquake etc.
2. Economic causes – e.g. Cyclical Fluctuations, Inflation, Demonstration Effect etc
3. Political causes – e.g. international relation, political instability, etc.
4. Social factors – e.g. change in taste and preferences etc.
A country’s balance of payments is said to be always ‘balanced’ in accounting sense so there
would be no ‘imbalance’ in a country’s BOP. However, we come across the term
‘equilibrium’ or ‘disequilibrium’ in relation to a country’s BOP. This is because the term
‘balance’/ ‘imbalance’ is used in accounting sense while the term ‘ equilibrium’ /
‘disequilibrium’ is used in economic sense. As Sodersten (1980) remarks - “The problem of
judging equilibrium position of a country’s balance of payments becomes fairly complicated
6
and soon takes us outside the sphere of book – keeping.” Thus, while analyzing the
equilibrium /disequilibrium in balance of payments one has to consider the nature of
international transactions in the BOP.
Autonomous & Accommodating Transactions
The nature of international transactions could be autonomous or accommodating.
(a) Autonomous Transactions – Autonomous transactions are those transactions that take place
regardless of the size of other items in the balance of payments. They are also called as
‘above the line transactions.’ All the transactions in the current and capital account are
autonomous because they are undertaken for business or profit motives and are independent
of balance of payments situations. They are the cause of BOP situation. For accounting
purposes it is reasonable to treat all the current and capital account transactions as
autonomous or above the line transactions. In brief, all the credit and debit entries in the
current and capital accounts are regarded as ‘autonomous’ transactions.
(b) Accommodating Transactions – Accommodating transactions are those transactions which
are undertaken deliberately to correct disequilibrium in balance of payments. They are also
called as ‘below the line transactions’. They are the result of balance of payments situation.
The transactions in the official reserve account are of accommodating nature undertaken by
monetary authorities to bring balances in the balance of payments. In brief, all the credit and
debit entries in the Official reserve account are regarded as accommodating transactions.
Definition of Equilibrium / Disequilibrium in Balance of Payments
The distinction between autonomous and accommodating transactions is useful in defining
equilibrium / disequilibrium (surplus / deficit) in balance of payments.
(a) Equilibrium in BOP - A country’s balance of payments is said to be in equilibrium when
its autonomous receipts (credits) are equal to its autonomous payments (debits).
Equilibrium in BOP → Autonomous Receipts = Autonomous Payments
(b) Disequilibrium in BOP - A country’s balance of payments is said to be in disequilibrium
when its autonomous receipts (credits) are not equal to its autonomous payments (debits).
Disequilibrium in BOP could be in the form of surplus or deficit in the balance of payments.

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 (1) Surplus in BOP – When the autonomous receipts (credits) are greater than autonomous
payments (debits), the balance of payments will be in surplus or favourable. In other words, if
total credits are more than total debits in the current and capital account (including errors &
omissions), the net credit balance measures the surplus in the nation’s balance of payments.
This surplus is settled with an equal amount of net debit in the official reserves account.
(2) Deficit in BOP – When the autonomous receipts (credits) are smaller than autonomous
payments (debits), the balance of payments will be in deficit or unfavourable or adverse. In
other words, if total debits are more than total credits in the current and capital accounts
(including errors & omissions), the net debit balance measures the deficit in the nation’s
balance of payments. This deficit is settled with an equal amount of net credit in the official
reserve account.
Types of Disequilibrium
Disequilibrium in balance of payments can be classified as follows: -
(a) Temporary Disequilibrium – Temporary disequilibrium in the form of deficits or surpluses
tend to last for a short period of time. They are the result of temporary changes in the
economy like - crop failure, seasonal fluctuations, effect of weather on agricultural
production, etc. Such disequilibrium may occur once a while and gets automatically
corrected. It does not pose a serious problem for a country.
(b) Fundamental Disequilibrium – There is no precise definition of the term fundamental
disequilibrium. Economists generally define fundamental disequilibrium as - “a deep rooted
persistent deficit or surplus in the BOP of a country.” It is a chronic BOP deficit, according
to IMF. It is of long term nature and a matter of serious concern for the country.
(c) Cyclical Disequilibrium – Cyclical fluctuations in the business activity also lead to BOP
disequilibrium. Cyclical disequilibrium occurs because – (i) Trade cycles follow different
paths and patterns in different countries. (ii) Different countries follow different stabilization
programmes. (iii) Differences in price and income elasticity’s of demand for imports.
(d) Structural Disequilibrium – Structural disequilibrium occurs due to structural changes in the
economy. Some of the structural changes would include – changes in technology, changes in
tastes and preferences, changes in long – term capital movements, etc.
Causes of Disequilibrium
The factors leading to disequilibrium (surplus or deficit) in balance of payments could be
broadly categorized into three –
(1) Economic factors – The important economic factors are (a) structural changes in the
economy, (b) changes in exchange rates (overvaluation / undervaluation), (c) Changes in the
level of foreign exchange reserves, (d) Cyclical fluctuations, (e) Inflation / deflation (f)
Developmental expenditure undertaken by developing countries, etc.
(2) Social factors – The social factors may include changes in tastes & preferences due to
demonstration affect, population growth rate, rate of urbanization, etc.
(3) Political factors – The political factors may include – political stability / instability in a
country, war, change in diplomatic policy, etc.
Correction Measures.
1. Monetary measures –
Deflation - Deflation means falling prices. Deflation has been used as a measure to correct
deficit disequilibrium. A country faces deficit when its imports exceeds exports.
 Deflation is brought through monetary measures like bank rate policy, open market
operations, etc. or through fiscal measures like higher taxation, reduction in public
expenditure, etc.
 Deflation would make our items cheaper in foreign market resulting a rise in our exports. At
the same time the demands for imports fall due to higher taxation and reduced income.

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 This would build a favourable atmosphere in the balance of payment position. However
Deflation can be successful when the exchange rate remains fixed.
2 Exchange Depreciation - Exchange depreciation means decline in the rate of exchange of
domestic currency in terms of foreign currency. This device implies that a country has
adopted a flexible exchange rate policy.
• Suppose the rate of exchange between Indian rupee and US dollar is $1 = Rs. 40. If India
experiences an adverse balance of payments with regard to U.S.A, the Indian demand for US
dollar will rise.
• The price of dollar in terms of rupee will rise. Hence, dollar will appreciate in external value
and rupee will depreciate in external value. The new rate of exchange may be say $1 = Rs.
50. This means 25% exchange depreciation of the Indian currency.
3. Devaluation - Devaluation refers to deliberate attempt made by monetary authorities to
bring down the value of home currency against foreign currency.
• When devaluation is effected, the value of home currency goes down against foreign
currency, Let us suppose the exchange rate remains $1 = Rs. 10 before devaluation. Let us
suppose, devaluation takes place which reduces the value of home currency and now the
exchange rate becomes $1 = Rs. 20.
• After such a change our goods becomes cheap in foreign market. This is because, after
devaluation, dollar is exchanged for more Indian currencies

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