FISCAL DEFICIT

FISCAL DEFICITPRESENTED BY:Ankit Gupta(05-MBA-12)Ankush Bagal (07-MBA-12)Manish Mahajan (20-MBA-12)Shivani Gupta (46-MBA-12)Virender Singh (56-MBA-12)Vishavdeep Sharma (58-MBA-12)DEFINITIONWhen a government's total expenditures exceed the revenue that it generates (excluding money from borrowings). Deficit differs from debt, which is an accumulation of yearly deficits.

A fiscal deficit is regarded by some as a positive economic event. For example, economist John Maynard Keynes believed that deficits help countries climb out of economic recession.

On the other hand, fiscal conservatives feel that governments should avoid deficits in favor of a balanced budget policy.

DEFICIT SPENDINGWhen a government's expenditures exceed its revenues, causing or deepening a deficit.

This excess spending needs to be financed through borrowing, likely from foreign governments.

The increased government spending can help stimulate the economy as more money flows in, but the jump in borrowing can have an adverse effect by raising interest rates.

John Maynard Keynes was an advocate of deficit spending as a fiscal policy tool to help stimulate an economy in recession.

During a recession, increased government spending can stimulate business activity, create jobs and spur consumer spending.

This creates a multiplier effect in which $1 of government spending helps increase GDP by more than $1.

Some complain that the negative effect of deficit spending is that interest rates will increase as the government borrows more.

The higher rates make borrowing money more expensive and can stifle growth.

FISCAL POLICYGovernment spending policies that influence macroeconomic conditions. These policies affect tax rates, interest rates and government spending, in an effort to control the economy.

Since the 1980s, most western countries have held a "tight" policy, limiting public expenditure.

FISCAL EFFORTThe amount of revenue collected by a government, often shown as a percent of the fiscal capacity.

This value creates an estimate of the total amount the government could collect in revenue.

The amount that a government collects in revenue, mainly taxes, is dependent on several factors.

This includes the tax rates for individuals and businesses, and the tax breaks and exemptions offered to the population.

The fiscal effort is also determined by the government's ability to enforce tax laws and collect the taxes.

FISCAL IMBALANCEA situation where all of the future debt obligations of a government are different from the future income streams.

Both of 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.

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.

To measure the fiscal imbalance, take the difference between the present value of all future debt and the present value of all income streams.

At any given time, there will be a fiscal imbalance for a particular government; a sustained and positive balance will be detrimental to society and the economy.

If there is a sustained positive fiscal imbalance, then tax revenues will likely increase in the future, causing both current and future household consumption to fall.

FISCAL DRAGFiscal drag is an economics term referring to a situation where a government's net fiscal position (equal to its spending less any taxation) does not meet the net savings goals of the private economy. This can result in deflationary pressure attributed to either lack of state spending or to excess taxation.

One cause of fiscal drag is the consequence of expanding economies with progressive taxation.

In general, individuals are forced into higher tax brackets as their income rises. The greater tax burden can lead to less consumer spending.

For the individuals pushed into a higher tax bracket, the proportion of income as tax has increased, resulting in fiscal drag.

Fiscal drag is essential a drag or damper on the economy caused by lack of spending or excessive taxation.

As increased taxation slows the demand for goods and services, fiscal drag results.

Fiscal drag is a natural economic stabilizer, however, since it tends to keep demand stable and the economy from overheating.

Because it is an economic stabilizer, fiscal drag can influence economic equality among citizens of the same region.

FISCAL CAPACITYIn economics, the ability of groups, institutions, etc. to generate revenue. The fiscal capacity of governments depends on a variety of factors including industrial capacity, natural resource wealth and personal incomes.

When governments develop their fiscal policy, determining fiscal capacity is an important step.

Identifying fiscal capacity gives governments a good idea of the different programs and services that they will be able to provide to their citizens.

It also helps governments determine the tax rate necessary to provide a certain level of programs.

The theory behind fiscal capacity can also be used by other groups, such as school districts, who need to determine what they will be able to provide to their students.

FISCAL AGENTAn organization, such as a bank or trust company, that takes responsibility for the fiscal duties of an unrelated party.

These fiscal responsibilities generally include the disbursement of interest and maturity payments on bonds, dividend payouts, and certain tax issues related to corporate securities.

How is FD bridged ?FD represent the extent to which the government needs fund, but does not have them.One simple way getting funds you dont have is to Borrow.GoI is the largest borrower in India. Annual borrowings of Govt. are probably larger then that of entire Corporate Sector.Besides, borrowing the govt. has another way of finding funds it does not have.

Being the law maker of the land gives the govt. the power to create money which is simply printing additional notes .This is called monetization.

How to make sense of FD number ? Is it good or bad?FD to some extent is fine. One typically looks at ratio of FD to gross domestic product. This ratio should ideally remain around 4% for a country like India. So says the IMF.A much higher number is bad news.Typically many nation and definitely developing nation, will run FD as govt, has the government has large role to play in the economy in areas like infrastructure, education, social support( India does not have this), defense, Civil admn. and so on. Government, Needs are likely to more then its income in a growing economy.

Why is FD so important?FD has a lot of impact on govt. policy. For example, if it turns out to be very high in a year the govt will have to either borrow a lot or print a lot of money. Borrowing a lot will push up interest rate their by making the economy costlier and reducing Competitiveness of goods produced Vis--vis those made by other country.

Printing lots of money breeds inflation, which is also bad beyond a point. Sustained high deficits can lead to very high accumulation of debt by the govt. leading to what is called internal debt trap.

How to keep FD in control?It is important keep FD within a limit for this there are obvious ways

Increase revenue or cut expenses or both. Revenue can be increased in three fashion- increase tax rate or tax more things or reduce tax evasion.

One example of tax more things is taxing agricultural income, currently free from levy in India.

In cutting expenses GOI has traditionally taken easier route. Like cutting infrastructure spending instead harder ones like cutting subsidies or freezing recruitment.

Fiscal Responsibility and Budget Management Act, 2003

The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) was enacted by the Parliament of India to institutionalize financial discipline, reduce India's fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget.

The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008.

However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009.

In 2011, given the process of ongoing recovery, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA.

BACKGROUNDThe historical balance of payments crisis of India resulted in several radical changes to the Indian economy, including the process of economic liberalisation in India.

Given, the deplorable financial condition of India, subsequent 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.12,000 billion rupees) Further 1,000 billion rupees of liabilities were being 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 year 2000 which subsequently went on to become the Fiscal Responsibility and Budget Management Act, 2003.

ENACTMENTThe FRBM Bill was introduced in India by the Finance Minister of India, Mr.Yashwant Sinha in December, 2000.

Firstly, the bill highlighted the terrible state of government finances in India both at the Union and the state levels under the statement of objects and reasons.

Secondly, it sought to introduce the fundamentals of fiscal discipline at the various levels of the government.

The FRBM bill was introduced with the broad objectives of eliminating revenue deficit by 31 Mar 2006, prohibiting government borrowings from the Reserve Bank of India three years after enactment of the bill, and reducing the fiscal deficit to 2% of GDP (also by 31st Mar 2006).

Further, the bill proposed for the government to reduce liabilities to 50% of the estimated GDP by year 2011.

There were mixed reviews among economists about the provisions of the bill, with some criticizing it as too drastic.

This bill was approved by the Cabinet of Ministers of the Union Government of India in February, 2003 and following the due enactment process of Parliament, it received the assent of the President of India on 26 August 2003.

Subsequently, it became effective on 5 July 2004.This would serve as the day of commencement of this Act.

OBJECTIVESThe main objectives of the act were:

To introduce transparent fiscal management systems in the country

To introduce a more equitable and manageable distribution of the country's debts over the years

To aim for fiscal stability for India in the long run

Additionally, the act was expected to give necessary flexibility to Reserve Bank of India(RBI) for managing inflation in India.

CONTENT OF THE ACTSince the act was primarily for the management of the governments' behavior, it provided for certain documents to be tabled in the Parliament annually with regards to the country's fiscal policy.

This included the following along with the Annual Financial Statement and demands for grants:

a document titled Medium-term Fiscal Policy Statement This report was to present a three-year rolling target for the fiscal indicators with any assumptions, if applicable.

This statement was to further include an assessment of sustainability with regards to revenue deficit and the use of capital receipts of the Government (including market borrowings) for generating productive assets.

A document titled Fiscal Policy Strategy Statement This was a tactical report enumerating strategies and policies for the upcoming Financial Year including strategic fiscal priorities, taxation policies, key fiscal measures and an evaluation of how the proposed policies of the Central Government conform to the 'Fiscal Management Principles' of this act.

A document titled Macro-economic Framework Statement This report was to contain forecasts enumerating the growth prospects of the country. GDP growth, revenue balance, gross fiscal balance and external account balance of the balance of payments were some of the key indicators to be included in this report.

The Act further required the government to develop measures to promote fiscal transparency and reduce secrecy in the preparation of the Government financial documents including the Union Budget.

FISCAL MANAGEMENT PRINCIPLESThe Central Government, by rules made by it, was to specify the following:

a plan to eliminate revenue deficit by 31 Mar 2008 by setting annual targets for reduction starting from day of commencement of the act.

reduction of annual fiscal deficit of the country

annual targets for assuming contingent liabilities in the form of guarantees and the total liabilities as a percentage of the GDP

BORROWINGS FROM RBIThe Act provided that the Central Government shall not borrow from the Reserve Bank of India(RBI) except under exceptional circumstances where there is temporary shortage of cash in particular financial year.

It also laid down rules to prevent RBI from trading in the primary market for Government securities.

It restricted them to the trading of Government securities in the secondary market after a April, 2005, barring situations highlighted in exceptions paragraph.

CRITICISMSome quarters, including the subsequent Finance Minister Mr. P. Chidambaram, criticized the act and its rules as adverse since it might require the government to cut back on social expenditure necessary to create productive assets and general upliftment of rural poor of India.

The vagaries of monsoon in India, the social dependence on agriculture and over-optimistic projections of the task force in-charge of developing the targets were highlighted as some of the potential failure points of the Act.

However, other viewpoints insisted that the act would benefit the country by maintaining stable inflation rates which in turn would promote social progress.Some others have drawn parallel to this act's international counterparts like the Gramm-Rudman-Hollings Act (US) and the Growth and Stability Pact (EU) to point out the futility of enacting laws whose relevance and implementation over time is bound to decrease.

They described the law as wishful thinking and a triumph of hope over experience. Parallels were drawn to the US experience of enacting debt-ceilings and how lawmakers have traditionally been able to amend such laws to their own political advantage.

Similar fate was predicted for the Indian version which indeed was suspended in 2009 when the economy hit rough patches.

Budget 2012: To make some amendments to FRBM act

Finance Minister in his Budget speech stated that FRBM implementation is back on track and there will be some amendments to FRBM act. This is what Pranab Mukherji had said in his Budget speech in February 2011. "The Thirteenth Finance Commission has worked out a fiscal consolidation road map for States requiring them to eliminate revenue deficit and achieve a fiscal deficit of 3 per cent of their respective Gross State Domestic Product latest by 2014-15.

It has also recommended a combined States' debt target of 24.3 per cent of GDP to be reached during this period. The States are required to amend or enact their FRBM Acts to conform to these recommendations."Fiscal deficit 2015Fiscal deficit seen at 3.9 percent of GDP in 2015/16Focus on meeting the challenging fiscal target of 4.1 percent of GDPRemain committed to meeting medium term fiscal deficit target of 3 percent of GDP

THANK YOU