Macroeconomics 2013-14

Government in the Business

Policy Economics
Fiscal Policy
 Introduction
• Public finance is one of the important branches of
economics.
• It deals with the finances of the public which in the context
of India could be identified as public bodies such as Local
self govts. Municipal corporations, State Govts /UTs and
Central Govt.
• All along till 1991 in a public sector dominated economy,
public finance played important role.
• Keynes emphasized the role of government expenditure
during depression to boost aggregate demand.
• National government announced an economic stimulus
package of $4 billion to shield its economy from recession
substantial increase in government expenditure coupled
with a cut in interest rates by Reserve Bank of India aim
towards raising aggregate demand during 2008-09
 contd..
• We have also learnt when we discussed aggregate
Demand and aggregate Supply that fiscal policy can
stimulate AD as well as AS.(How ?)
• AD= C+I+ G+ X-M, where G comprises of government
consumption and government investment(What are
other components ?)
• Obviously the nature and quality of govt expenditure
such as whether govt expends on non productive
consumption such as revenue expenditure viz,
subsidies, interest payments, transfer payments etc or
expends on investment such as infrastructure will
impact the growth.(Why- apply investment multiplier
concept)
 Fiscal Policy
• Objectives:
• Meaning and scope of fiscal policy
• How fiscal policy helps in achieving the overall
objective of growth and economic development
through fiscal instruments.
• What is Budget, concepts of deficit and other
components.
• How to analyse budget and implications of fiscal
deficit on growth.
 Fiscal Policy
Definition
It refers to govt.’s programs of taxation,
expenditure and public borrowings with a
view to achieve certain national
goals/objectives.
Objectives
- Economic Growth
- Promotion of employment
- Macro Economic Stability
- Economic Justice or Equity
 Contd....
Key to Growth
- High overall investment
- High productivity (incremental capital output
ratio which is 1:4 which means in order to
produce one unit of output we require 4 units
of capital. In such case, if we want to achieve
8% growth, we require 32% investment)
- High investment in infrastructure and
education
Key culprits to Growth
- High fiscal deficit of central and state govts.
- High non plan expenditure
 How It Works
• Fiscal policy is also known as Budgetary Policy
and is reflected by Union Budget.
• Budget has two sides: Inflows and outflows.
• By its statutory powers, govt can influence
inflows(receipts) and outflows(expenditure) and
thereby the macroeconomic variables such as agg
consumption, pvt savings and investment by
altering taxation, govt spending, and borrowings.
 Fiscal Instruments
• Government Expenditure, Taxation, Public
Borrowings, Budgetary balance are known as
fiscal instruments.
• Budget could be: Balanced Budget, Surplus
Budget, Deficit Budget.
• Govt. Revenue Expenditure takes place due to
public spending on purchases of goods and
services, transfer payments such as pensions,
subsidies, unemployment allowance, grants and
aid, payments of interest, and amortisation of
loans.
• Govt. capital expenditure on new roads, new
buildings, ports etc.
 Plan and Non plan expenditure
Plan expenditures are estimated after discussions
between each of the ministries concerned and the
Planning Commission and refer to the additional
expenditure to be made, both on the capital and revenue
account, the current fiscal year.
Non-plan revenue expenditure is accounted for by
interest payments, subsidies (mainly on food and
fertilisers), wage and salary payments to government
employees, grants to States and Union Territories
governments, pensions, police, economic services in
various sectors, other general services such as tax
collection, social services, and grants to foreign
governments(continuing from prvious years)
Non-plan capital expenditure mainly includes defence,
loans to public enterprises, loans to States, Union
Territories and foreign governments.
 Development expenditure and non
development expenditure
- The important heads of developmental expenditure
within the revenue account are (i) social and
community services, (ii) economic services and (iii)
grants- in-aid to states and union territories. The largest
component in this group is economic services.
- Economic services include general economic services,
agriculture and allied services, industry; and minerals,
water and power and power development, transport and
communication, railways, post and telegraphs etc.
- The components of development expenditure on capital
account are: (i) loans and advances to states and union
territories, (ii) loans for social and community
development services and (iii) loans for economic
services.
 Non development expenditure
- Non-development expenditure on revenue account
include (i) general services consisting of fiscal services,
interest payments, administrative services, defence
services etc and (ii) grants- in-aid to states and union
territories and also to foreign countries.
- Non-development expenditure on capital account
includes loans and advances to states and union
territories and advances to foreign countries.
- The biggest components of non-development
expenditure have been (i) the defence services and (ii)
interest payments on public debt.
 Govt. receipts:revenue receipts and capital
receipts
• Tax revenue: Direct taxes and Indirect taxes(revenue
receipts)
• Direct Taxes: income tax, corporate tax, wealth and
property tax(tax on income and income related assets)
• Indirect Taxes: Excise, sales tax, customs and various
state/local bodies taxes- motor vehicles tax, stamp
duty tax, service tax (tax on commodities and
services).
• Non tax revenue: interest and dividend received from
PSUs and fees, lotteries, user charges, auctions etc.
• Tax revenue and non tax revenue are revenue receipts.
 Capital receipts
- Recovery of loans and Public sector disinvestment are
capital receipts.
- Other short, medium and long term loans
- External assistance
- State provident funds, special deposits
- Total revenue receipts from tax revenue,direct and
indirect, and non tax revenue and capital receipts are
known as Government own money for the current year.
- Government receipts however include both government
own money as well as borrowings.
 Govt Expenditure
• Non Plan revenue Expenditure- Revenue
Expenditure such as interest payment,
defence services, subsidies, social services,
grants to foreign govts.
• Non plan capital expenditure: Defence
services, loans to public enterprises, Loans to
state and UT govts
• Plan expenditure:Revenue expenditure and
capital expenditure: Central Plan and central
assistance to State and union territory Plans
 Public Borrowings
• Internal Borrowings:(1) Borrowings from the public
by means of government bonds, and treasury bills and
other liabilities such as small savings and, provident
fund etc. (2) Borrowings from the central bank, i.e.
deficit financing.
• The first leads to high interest rates, the second leads
to inflation
• Both have different implications. The former is
transfer of purchasing power from public to govt and
the latter monetisation of deficit with inflationary
implications.
• External Borrowings from foreign govts, international
organisations such as IMF, World bank, Asian
Development Bank. It leads to destabilisation of
currency
• If the fiscal deficit is financed by high taxation, it will
be inimical to the growth of private sector.
 The Indian Budget

Intentions Vis-à-vis Realities

 Budget at a glance:13-14(Rs. Crs.)
- 1. Revenue Receipts:1056331
2. Tax Revenue(net to centre):884078
3. Non-Tax Revenue: 172252
-4.Capital recpts: 608967(gov own recpts66468-10.91% ofCR
5. Recoveries of loan:10654
6. Other receipts:55814
7. Borrowings and other liabilities:542499
-8. Total receipts:1109975
-9. Non Plan expediture:1109975
10. On revenue account:992908
11. Of which interest payment:370684 (37.33% of NPE, 68.3%
of 7, fiscal deficit)
12. On capital account:117067
 Contd..
- 13. Plan expenditure:555322
14.On Revenue Account 443260
15.On Capital Account:112062
16. Total Expenditure (9+13):1665297
17.Revenue Expenditure (10+14):1436169
18.Of Which,Grants for creation of Capital
Assets:174656
19.Capital Expenditure (12+15):229129
20. Revenue Deficit (17-1): 379838 (3.3 of GDP)
21. Effective Revenue Deficit (20-18):205182(1.8 of gdp)
22. Fiscal Deficit {16-(1+5+6)}: 542499 (4.8 of gdp)
23. Primary Deficit (22-11): 171814 (1.5 of gdp)
 Central govt. Receipts(2013-13):Rs. crs
Gross tax receipts: 1235870
Corp tax: 419520(33.95%), Income tax: 247639(20.03%),
Union excise: 197554(15.98),Customs: 187308(15.15%),
Service tax: 180141(14.61), Wealth tax: 950(0.8%)
States share in tax: 351792
National calamity contingency fund: 4800
Centre net tax revenue: 884078(83.69%) or7.7% of
GDP which is estimated at Rs. 11,371,886crs in 13-14
----------------------------------------------------------------------
Total Non-tax revenue:172252(16.31%ofCentre's TR)
Interest receipts:17764(16.63%),Dividend andProfits:
73866(41.56%),External Grants:1456(2.43%) Other Non
Tax Revenue:78000(38.46%),Receipts of Union
territories 11166(0.83%)
Total Revenue Receipts: 1056331
 Capital receipts:13-14
Non-debt Receipts: 66468
Recoveries of loans and advances:10654
Miscellaneous Capital Receipts:55814
Debt receipts:542499
Market loans:484000
Short term borrowings:19844
External assistance net:10560
State provided fund:10000
Securities issued against Small savings:5798
Other receipts: 12297
Total Captial receipts:608967
Central Govt. Expenditure(2013-14):Rs.
crs

Total Non-Plan Expenditure:1109975 (100%)

Revenue non-plan exp: 992908 (89%)
Capital non-plan exp : 117067(11%)
---------------------------------------------------------------
Total plan exp: : 555322 (100%)
Rev. plan exp : 443260 (80%)
Capl plan exp: 112062 (20%)
---------------------------------------------------------
Total expenditure : 1665297(100%d)-14.64% of gdp
Total NPE as % of TE : 66.65%
Total PE as % of TE: 33.35%
Total CE (Plan+non plan): 229129 (13.76%)
Plan capital exp growth: 30% over 2011-12
Plan revenue exp growth: 29% over 2011-12
 Important components of exp:13-14
a)Total debt servicing: 537756(35.09%ofRR,32.3% of TE
b) Defence : 203672 (12.23 % of TE)
c) Subsidies : 231084(13.9% of TE,21.9 ofRR,2%of
gdp)
d) Gen. Services(police, pensions) 111621(6.7)
Total (a+b+c+d) : (65% of TE)
e) Social services- Non plan : 23114(1.4)
f) Eco. Services- Non plan : 24334(1.5)
g) Postal deficit- non plan : 6717(0.4)
- Remaining 35% of TE goes to central plan, central
assistance to states and UTs

Interest payment :370684( 35.74% of RE, 3.26% of gdp)

Total debt servicing: 4.72% of GDP
 Concepts of Deficits
* Budget Deficit- Excess of total Budgetary
expenditure over total budgetary receipts.
*Revenue Deficit- Excess of revenue expenditure over
revenue receipts. Revenue Expenditure are those that
does not result in capital formation.
*Fiscal Deficit- Excess of total expenditure over govt
own receipts (excluding). This measure was adopted by
IMF as the principal policy target in evaluating the
performance of countries seeking assistance.
*Primary Defcit- Fiscal Deficit less interest payment.
It suggets whether the fiscal deficit is because of the
interest paid on the debt accumulated over the years or
this govt has also resorted to borrowing to meet its
current expenditure.
 Concepts of Deficits
* Budget Deficit- Excess of total Budgetary
expenditure over total budgetary receipts.
*Revenue Deficit- Excess of revenue expenditure over
revenue receipts. Revenue Expenditure are those that
does not result in capital formation.
*Fiscal Deficit- Excess of total expenditure over govt
own receipts (excluding). This measure was adopted by
IMF as the principal policy target in evaluating the
performance of countries seeking assistance.
*Primary Defcit- Fiscal Deficit less interest payment.
It suggets whether the fiscal deficit is because of the
interest paid on the debt accumulated over the years or
this govt has also resorted to borrowing to meet its
current expenditure.
 How does the FP work: Discretionary, non
discretionalry and compensatory policies

- It works through the non-discretionary and discretionary

budgetary policies of the govt.
- Non-discretionary fiscal policies are those that automatically
happen. A progressive income tax and welfare system both
act to increase the aggregate demand in recessions and to
decrease aggregate demand in expansions.
- During slowdown, due to progressive income tax, tax
proceeds automatically go down and govt. Expenidture goes
up and vice versa. This automatic changes in the govt
expenditure and income tax proceeds happen through
automatic stabilisers.
- Obviously during slowdown govt. Reciepts decline and govt
expendire increases which increases the fiscal deficit.
 Discretionary policies
- Discretionary fiscal policies refer to the chages made by the
govt in various instruments of fiscal policies such as taxes,
expenditure, borrowings etc, to achieve some policy
objectives. For example in 1997 Chidambaram broght down
the tax rates and tax slabs; during 2008-09 govt gave a
stimulus of $ 4 billion to industry to arrest the slowdonw.
- Let us assume, govt increase G by Rs. 100/- which means
AD will icrease by Rs. 100 as G is one component of AD in
the first round. Rs. 100/- exp by govt is paid to FOPs who
spend Rs. 75 on consumption (MPC: 0.75) and save Rs. 25.
In the second round 75% of 75 or Rs. 56 is spent, in the
third round Rs. 42 is spent and it goes on and ultimately Rs.
100 increase in G leads to Rs. 400 increase in AD.
- In case of reduction in Tax by Rs. 100 reults into Rs. 75 exp
on consumption (mpc is .75) in the first round and so on so
forth. Thus Tax multiplier is smaller than G multiplier.
- However, the multiplers do not work in a straightjacket
manner. There are leakages.
 Compensatory policies
- Compensatory polcities refer to Surplus budgeting or defcit
budgeting. Deficit budgeting by borrowing and financing
the govt expendiutre is the popular practice across the
world.
- Govt can finance its budget by:I- borrowing from the RBI, II-
borrowing from domestic market, III- borrowing from
abroad and IV- Increased taxes.
- The first one refers to picking up of govt securities from the
primary mkt and increasing money supply. This is known as
monetisation of deficit and it is inflationary in nature.
- The second one refers to issuing of bonds by RBI whch are
subscribed by banks, financial institutions, HNIs. In this
case demand for money increases and rate of interest goes
up which results into crowing out of pvt investment, more
capital inflow of money from abroad, appreciation of
domestic currency and decline in exports.
 Contd...
- The third one refers to the widening of M-X for which
govt borrows from IMF, World bank, ADB etc. If the
imports does not generate commensurate returns, it
results into depreciation of domestic currency and the
resultants results of loss of faith in the rupee.
- The fourth mode of borrowing refers to increasing tax
rates. Increase in income tax plays out as an
disincentives for the producers and thereby slows down
the growth rate and vice versa.
- Increasing indirect taxes results in to increase in prices
and change in the relative prices of the goods and
services and impacts AD. Widening of tax base is
better rather than to increase taxes.
 Critical examination between the
fiscal deficit and growth
* India’s fiscal deficit is one of the highest in the world.
- It was 5.99%, 6.46, 4.79, 5.75 and 5.75% during 2008-09 til
12-13.
* It is argued that large structural primary deficits and interest
payments relative to GDP have had an adverse effect on
growth in recent years.
- external Debt service-gdp ratio has increased from 1.87% in
1995-96 to 3.70% in 2012-13.
- Tax revevnue share was 8.18% in 06-07 which is estaimated
at 7.7% during 13-14.AE was 14.64% as against 13.58% of
gdp in 06-07.
 Contd..
- External debt was $360.4 billion in 2012-13 of which short
term debt was $83.2. The corrosponing figures for 1999-
2000 were $98.3 and $3.9 billion respectively.

* There is a clear need to bring down the combined debt-GDP

ratio from its current level.

* High level of fiscal deficit relative to GDP tend not only to

cause sharp increase in debt equity ratio, but also adversely
affect savings and investment and consequently growth.
 Fiscal policy instruments and target variables

- Privarte disposable income, private consumption

expenditure, private savings, private investment,
imports and exports, level and structure of prices and
growth.
- Write a note on how fiscal instruments impact on target
variables?
 FAQs
- What are direct and indirect taxes and what are their
implications on disposable income, consumption, savings
and investment and overall growth
- What impact does budget on the market economy and how?
-What is capital budget, what is revenue budget in terms of
thieir receipts and expendiutre ?
- What is fiscal policy and what are its instruments and how do
they impact on target variables?
- What is plan and non plan expenditure?
- What are various modes of financing of deficit budegeting
and their implications and which one is best suited to indian
economy?
- What are fiscal deficit, budget deficit, revenue deficit and
primary deficit?
 Important questions

- Why Fiscal deficit is decried and what are its implications

and what measures you suggest to tackle the problem of
fiscal deficit- Refer chidambaram 10 point agenda of
growth?
- Is there any way of reducing the govt's revenue expenditure
to reduce the size of revenue deficit?
- What are the chaces that tax revenues can be substantially
stepped up to ease reveune deficit?
- What are the trade offs between the disinvestment of PSUs
and redemption of debt liabilities?