Fiscal Responsibility and Budget Management

Certificate Course in Indirect Tax

FISCAL RESPONSIBILITY AND BUDGET MANAGEMENT

Presented by

CA Paras Savla

On

19 August 2012

BACKGROUNDDeficit Budgeting

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F I S C A L R E S P O N S I B I L I T Y & B U D G E T M A N A G E M E N T

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

KEYNESIAN ECONOMICS


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The General Theory of Employment, Interest and Moneypublished by Keynes in 1936.It argued in the favour of budget deficits and increasesin the money supply to restore economic growth.The prevailing view among both economists andpoliticians of the time was that government budgetsshould be balanced and that the money supply shouldbe tied to the gold standard.Keynes believed that workers would never allow wagerates to fall enough to eliminate unemployment. Hethus favored inflationary policies that would cause thereal level of wages to fall even though nominal ratesremained unchanged.

SOURCE CODE – DEFICIT BUDGET


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After the World War II Keynesian policies became the foundation of botheconomic theory and economic policy in all Western nations.

The United States, for example, codified Keynesian economics in theEmployment Act of 1946, which obliged the government to utilize Keynesianpolicies to sustain full employment.

By the 1960s, Keynesian economics dominated economic policymaking in theU.S. The Kennedy tax cut of 1964 was explicitly based on Keynesianeconomics and by 1971 even President Richard Nixon confessed to being aKeynesian. However, the development of rapid inflation and slow growth inthe 1970s, combined with rising budget deficits, severely eroded the credibilityof Keynesian policies.

SPREAD OF KEYNESIAN POLICIES


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Professor Milton Friedman of the University of Chicago, hadalways viewed it as dangerously inflationary. The stagflation ofthe 1970s appeared to confirm this view.Professor Martin Feldstein of Harvard, expressed concernedabout the growth of budget deficits and began to view them as adrag on the economy.Austrian economist Friedrich Hayek criticized policies for whathe called their fundamentally "collectivist" approach, arguingthat such theories encourage centralized planning, which leads tomalinvestment of capital, which is the cause of business cyclesBy the 1980s, most economists had already turned away fromKeynesian economics, although many of its doctrines continueto be embedded in economics textbooks.The advent of the global financial crisis in 2008 has caused aresurgence in Keynesian thought.

CRITICS OF KEYNESIAN ECONOMICS


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INTERNATIONAL SCENARIOPost Keynesian

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

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

GRAMM–RUDMAN–HOLLINGS BALANCED BUDGET ACT


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Budget and Emergency Deficit Control Reaffirmation Act of 1987; TheBudget Enforcement Act of 1990

The Act created two new budget control processes: a set of caps on annually-appropriated spending, and a "pay-as-you-go" or "PAYGO" process forentitlements and taxes. But the law departed from the fixed deficit targets ofGramm-Rudman-Hollings.

Pay-As-You-Go Act of 2010

Like the BEA, new law brought back the requirement that the Administrationsend up a Constitutionally valid sequester order to Congress if Congressincreases mandatory spending or decreases taxes in a way that, on net,increases the deficit. However, this law was lacking in Gramm-Rudman'sdiscretionary spending caps, and so was considerably less powerful as a checkon appropriated discretionary spending.

SERIES OF LAWS TO CONTROL DEFICIT

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INCREASE SPENDING'S

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

STABILITY AND GROWTH PACT

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The actual criteria that member states must respectare: an annual budget deficit no higher than 3% ofGDP (this includes the sum of all public budgets, includingmunicipalities, regions, etc.) and a national debt lower than60% of GDP or approaching that value

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The Pact has proved to be unenforceable against big countriessuch as France and Germany, which were its strongest promoterswhen it was created. These countries have run "excessive"deficits under the Pact definition for some years. The reasonsthat larger countries have not been punished include theirinfluence and large number of votes on the Council of Ministers.In March 2005, the EU Council, under the pressure of Franceand Germany, relaxed the rules.In March 2011, following the 2010 European sovereign debtcrisis, the EU member states adopted a new reform under theOpen Method of Coordination, aiming at straightening the rulese.g. by adopting an automatic procedure for imposing ofpenalties in case of breaches of either the deficit or the debtrules.

EU RECENT SCENARIO

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INDIAN SCENARIO

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Considering the deplorable financial condition of India, Governments formedseveral commissions and laws to improve the financial situation of the country. Bythe year 2000, at the Central Government level, India was running total liabilitiesequivalent to 6 times its annual revenue (Rs 12,000 billion) and Rs 1,000 billion ofliabilities added every year. The interest payments alone were consuming one-thirdsof the tax revenue (or 50% of the government revenue) of India due to increasedGovernment borrowings to fund the persistently rising revenue deficits of thecountry. In the light of this need for change, the NDA government of Indiaintroduced the Fiscal Responsibility and Budget Management Bill in 2000 whichsubsequently went on to become the Fiscal Responsibility and Budget ManagementAct, 2003.

FISCAL MANAGEMENT

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An Act to provide for the responsibility of the Central Government to ensureinter-generational equity in fiscal management and long-term macro-economicstability by achieving sufficient revenue surplus and removing fiscalimpediments in the effective conduct of monetary policy and prudential debtmanagement consistent with fiscal sustainability through limits on the CentralGovernment borrowings, debt and deficits, greater transparency in fiscaloperations of the Central Government and conducting fiscal policy in amedium-term framework and for matters connected therewith or incidentalthereto.

FRBM ACT OBJECTIVE

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Fiscal deficit - the excess of total disbursements, from the ConsolidatedFund of India excluding repayment of debt, over total receipts into the Fund(excluding the debt receipts), during a financial year.Revenue deficit - the difference between revenue expenditure and revenuereceipts which indicates increase in liabilities of the Central Governmentwithout corresponding increase in assets of Government.Fiscal indicators - the measures such as numerical ceilings and proportionsto gross domestic product, as may be prescribed, for evaluation of the fiscalposition of the Central Government.

FEW CONCEPTS

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The Central Government shall lay in each financial year before both Housesof Parliament the following statements of fiscal policy along with the annualfinancial statement and demands for grants

(a) Medium-term Fiscal Policy Statement

(h) Fiscal Policy Strategy Statement;

(c) Macro-economic Framework Statement

(d) Medium-term Expenditure Framework Statement

POLICY STATEMENT TO BE LAID BEFORE PARLIAMENT

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It shall set forth a three-year rolling target for prescribed fiscal indicators withspecification of underlying assumptions and shall include• the assessment of sustainability relating to the balance between revenue

receipts and• revenue expenditures and the use of capital receipts including market

borrowings for generating productive assets.

MEDIUM-TERM FISCAL STATEMENT

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The policies of the Central Government for the ensuing financial year relatingto taxation, expenditure. market borrowings and other liabilities, lending andinvestments, pricing of administered goods and services, securities anddescription of other activities such as underwriting and guarantees which havepotential budgetary implications.

The strategic priorities of the Central Government for the ensuing financialyear in the fiscal area.The key fiscal measures and rationale for any major deviation in fiscalmeasures pertaining to taxation, subsidy, expenditure, administered pricing andborrowings.An evaluation as to how the current policies of the Central Government are inconformity with the fiscal management principles and the objectives set out inthe Medium-term Fiscal Policy Statement

FISCAL POLICY STRATEGY STATEMENT

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It shall contain an-assessment of the growth prospects of the economy withspecification of underlying assumptions and shall contain• the growth in the gross domestic product,• the fiscal balance of the Union Government as reflected in the revenue

balance and gross fiscal balance and• the external sector balance of the economy as reflected in the current

account balance of the balance of payments

MACRO-ECONOMIC FRAMEWORK STATEMENT

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It set forth a three-year rolling target for prescribed expenditure indicatorswith specification of underlying assumptions and risk involved, shall contain• the expenditure commitment of major policy changes involving new

service, new instruments of service, new schemes and programmes• the explicit contingent liabilities, which are in the form of stipulated

annuity payments over a multi-year time-frame• the detailed breakup of grants for creation of capital assets.This statement is newly added in the family post amendment by the FinanceAct 2012. Hence first such statement would be published along with FianceBill 2013.

MEDIUM-TERM EXPENDITURE FRAMEWORK STATEMENT

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To reduce fiscal deficit and revenue deficit -

• so as to eliminate revenue deficit by 31st March 2008, with a minimumannual reduction by 0.5% of GDP and

• to reduce the fiscal deficit by an amount by at least 0.3% of the GDP, sothat fiscal deficit is less than 3 per cent of GDP by the end of 2008-2009

To limit guarantees to at most 0.5 per cent of the GDP in any financial year

To limit additional liabilities (including external debt at current exchange rate)to 9% of GDP in 2004-05, 8% of GDP in 2005-2006, 7% of GDP in 2006-2007.

FISCAL MANAGEMENT PRINCIPLES

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The targets were not achieved because the global credit crisis hit the marketsin 2008 and the government had to roll out a fiscal stimulus to revive theeconomy and this increased the deficits.In the 2011 budget, the finance minister said that the FRBM Act would bemodified and new targets would be fixed and flexibility will be built in to havea cushion for unforeseen circumstances. According to the 13th FinanceCommission, fiscal deficit will be brought down to 3.5% in 2013-14. Likewise,revenue deficit is expected to be cut to 2.1% in 2013-14.In the 2012 Budget speech, the finance minister announced an amendment tothe FRBM Act. He also announced that instead of the FRBM targeting therevenue deficit, the Government will now target the effective revenue deficitby 31st March 2015 and reach revenue deficite of 2% of GDP by 31st March2015.

CURRENT SCENARIO

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LIGHTER MOVEMENTS

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S. No.

Fiscal Indicators Revised Estimates

2011-12

Budgeted Estimated

2012-13

Target for 2013-14 2014-15

1Effective Revenue Deficit 2.9 1.8 1 0

2 Revenue Deficit 4.4 3.4 2.8 23 Fiscal Deficit 5.9 5.1 4.5 3.94 Gross Tax Revenue 10.1 10.6 11.1 11.7

5.

Total outstanding liabilities at the end of the year 45.7 45.5 44 41.9

6. Interest to Gross tax 42.9 41.5 39.0 35.9

FISCAL INDICATORS – ROLLING TARGETS AS PERCENTAGE OF GDP

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2011-12 2012-13 2013-14 2014-15

Fiscal Deficit

MTFP 5.9 5.1 4.5 3.913th FC 4.8 4.2 3 3Revenue Deficit

MTFP 4.4 3.4 2.8 213th FC 2.3 1.2 0 -0.5Debt*

MTFP 45.7 45.5 44 41.913th FC 52.5 50.5 47.5 44.8* Excluding NSSF Loans to States, Loans under MSS and accounting for external debt at current exchange rate.

FISCAL ROAD MAP COMPARISON

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Concept of “Effective Revenue Deficit” was introduced by amendment toFRBM Act.

Effective Revenue Deficit is the difference between revenue deficit andgrants for creation of capital assets. This will help in reducing consumptivecomponent of revenue deficit and create space for increased capital spending.In other words, capital expenditure will now be removed from the revenuedeficit and whatever remains (effective revenue deficit) will now be the newgoalpost of the fiscal consolidation eg non-plan expenditure to set up powerplant would not be called revenue deficit because it is towards maintaining acapital asset.

CRAFTY ACCOUNTING

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Prior to the FRBM Act, Central Government deficits were financed throughmonetisation of deficits by the RBI (a process known as ‘Deficit Financing’).The state governments have no such facility and their deficits had to be metthrough borrowings from the central government.

The FRBM Act envisaged complete phase out of monetisation of deficits byRBI from 2006. Central Government budgetary deficits were to be metthrough market borrowings. State governments could borrow from market aswell. FRBM equivalents were proposed for state governments.

FRBM had imposed complete ban to borrow directly from the RBI. Butallowed temporary borrowing from RBI to meet excess of cash disbursementover cash receipts during any financial year as per the agreed terms.

BORROWING FROM RBI

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

BORROWING FROM RBI

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The Central Government shall take suitable measures to ensure greatertransparency in its fiscal operations in the public interest and minimise as faras practicable, secrecy in the preparation of the annual financial statement anddemands for grants.

The Central Government shall, at the time of presentation of annual financialstatement and demands for grants, make prescribed disclosures and inprescribed form

OBLIGATIONS

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The Finance Minister shall review every quarter the trends in receipts andexpenditure in relation to the budget and place before both Houses ofParliament the outcome of such reviews.

In case of shortfall in revenue or excess of expenditure over the pre-specifiedlevels mentioned in the Fiscal Policy Strategy Statement or the rules duringthe financial year, the Central Government shall take appropriate measures forincreasing revenue or for reducing the expenditure including curtailing of thesums authorised to be paid and applied from and out of the ConsolidatedFund of India under any Act so as to provide for the appropriation of suchsums.

REVIEW & CORRECTIVE MEASURES

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No deviation in meeting the obligations cast on the Central Government under thisAct, is permissible without Parliament’s approval and in case of deviation due tounforeseen circumstances Finance Minister shall explain in the Parliament

• deviation in meeting the obligations

• whether such deviation is substantial and relates to the actual or the potentialbudgetary outcomes and

• the remedial measures proposed to be taken

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

DEVIATION

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

MISCELLANEOUS PROVISIONS

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LET’S DISCUSS

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THANK YOU

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Fiscal Responsibility and Budget Management

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Transcript of Fiscal Responsibility and Budget Management