Public Finance in India

Revenue Deficit, Fiscal Deficit, and Primary Deficit are key indicators used to assess a government's financial health.

I. Revenue Deficit = ₹20,000 crores – Correct

* Definition: Revenue Deficit = Revenue Expenditure − Revenue Receipts * Calculation: ₹80,000 crores − ₹60,000 crores = ₹20,000 crores

II. Fiscal Deficit = ₹10,000 crores – Correct

* Definition: Fiscal Deficit = Total Expenditure − Total Receipts (excluding borrowings) * Alternatively, it reflects total borrowings needed to meet the gap * Given: Borrowings = ₹10,000 crores ⇒ Fiscal Deficit = ₹10,000 crores

III. Primary Deficit = ₹4,000 crores – Correct

* Definition: Primary Deficit = Fiscal Deficit − Interest Payments * Calculation: ₹10,000 crores − ₹6,000 crores = ₹4,000 crores

Fiscal Deficit represents the government's total borrowing requirement, while the Primary Deficit shows how much the government is borrowing excluding interest payments on past debt.

Formula: Primary Deficit = Fiscal Deficit − Interest Payments

Given:

* Fiscal Deficit = ₹50,000 crores * Interest Liabilities = ₹1,500 crores * Non-debt capital receipts are already factored into the fiscal deficit, so no need to adjust further.

Calculation: Primary Deficit = ₹50,000 − ₹1,500 = ₹48,500 crores

The 15th Finance Commission made recommendations to promote better fiscal discipline, education, and agriculture reforms, while adjusting tax devolution among states.

Statement I: Correct 4,800 crores were recommended (2022–23 to 2025–26) to incentivize states for improving educational outcomes.

Statement II: Incorrect The Commission recommended 41% of Union taxes to be shared with states, not 45%.

Statement III: Correct It proposed a ₹45,000 crore performance-based incentive for states to implement agricultural reforms.

Statement IV: Correct It reintroduced the 'tax effort' criterion, rewarding states that better mobilize revenue in relation to their GSDP.

Capital receipts involve transactions that either increase liabilities or reduce assets for the government. Revenue receipts, on the other hand, are routine incomes like interest or taxes that don't affect assets or liabilities.

Statement I: Correct * Capital receipts create liabilities (like borrowings) or reduce assets (like disinvestment).

Statement II: Correct * Borrowings and disinvestment are both capital receipts.

Statement III: Incorrect * Interest received is a revenue receipt, not a capital receipt—it's income, not a liability.

* Statement-I: This statement is correct. If the United States of America (USA) were to default on its debt, holders of US Treasury Bonds would not be able to exercise their claims to receive payment. This statement is correct because, in the event of a default, the government would not be able to fulfil its debt obligations, meaning bondholders would not receive the payments they are due.

* Statement-II: This statement is correct. The US government debt is not backed by any hard assets, but only by the faith of the Government. This statement is also correct. US Government debt, such as Treasury Bonds, is backed by the full faith and credit of the US Government rather than any specific physical assets.

* Statement II explains Statement I because the faith and credit of the US Government are the guarantees behind its debt. If this faith is shaken or if the government defaults, bondholders cannot claim any specific assets to recover their investment, hence they would not receive their payments.

The Fifteenth Finance Commission (XVFC) recommended the following criteria and weights for horizontal tax devolution among states for the 2021-26 period:

1. Income Distance (45%): The distance of a state's income from the state with the highest income. 2. Population (15%): Based on the 2011 Census data. 3. Area (15%): To account for the higher cost of providing services in larger geographical areas. 4. Forest and Ecology (10%): Calculated based on the share of the dense forest of each state in the total dense forest of all states. 5. Demographic Performance (12.5%): This criterion was introduced to reward states that have made progress in lowering their fertility rates (using 1971 population data as a benchmark). 6. Tax and Fiscal Efforts (2.5%): To reward states with higher tax collection efficiency.

Analysis of the given list: - Demographic performance: Included (Criterion 5) - Forest and ecology: Included (Criterion 4) - Tax and fiscal efforts: Included (Criterion 6) - Governance reforms: Not included as a criterion for horizontal devolution. - Stable government: Not included as a criterion for horizontal devolution.

Apart from population, area, and income distance, the Commission used three criteria from the list provided (Demographic performance, Forest and ecology, and Tax and fiscal efforts).

Statement 1 is Correct: Reducing revenue expenditure (spending that does not create assets or reduce liabilities, such as interest payments, salaries, and administrative costs) lowers the total government outgo, thereby reducing the budget deficit. Statement 2 is Incorrect: Introducing new welfare schemes increases government spending (typically revenue expenditure), which would widen the budget deficit rather than reduce it. Statement 3 is Correct: Rationalizing subsidies involves making them more targeted (e.g., through Direct Benefit Transfer) to eliminate leakages and reduce wasteful revenue expenditure, which helps in narrowing the deficit. Statement 4 is Incorrect: Reducing import duties decreases the government's tax revenue (receipts). A decrease in revenue, assuming expenditure remains constant, leads to an increase in the budget deficit.

Statement 1 is correct: This is a classic example of Capital Expenditure. This type of spending creates physical assets for the country and is long-term in nature. Therefore, it is included in the capital budget.

Statement 2 is correct: This is a Capital Receipt. When the government receives a loan, it creates a liability (it has to be repaid in the future). Since it affects the government's liabilities, it is part of the capital budget.

Statement 3 is correct: This is also a form of Capital Expenditure. When the central government grants a loan, it creates a financial asset for itself (the loan is an asset that will earn interest and be repaid). As this spending creates an asset, it is included in the capital budget.

Since all three items are either capital expenditures or capital receipts, they are all part of the Capital Budget of the Government of India.

To reduce a persistent budget deficit, the government can take actions that decrease spending or increase revenue.

1. Reducing revenue expenditure (Correct): This involves cutting back on non-essential government spending. This can include areas like administrative costs, travel, or certain subsidies. 2. Introducing new welfare schemes (Incorrect): This would likely increase government spending and worsen the deficit. 3. Rationalizing subsidies (Correct): Subsidies can be a significant source of government expenditure. Reviewing and potentially reducing or reforming subsidies can help control spending. 4. Expanding industries (Depends): While industrial expansion can lead to increased tax revenue in the long run, it might not have an immediate impact on the budget deficit. In the short term, the government might need to invest in infrastructure to support expansion, potentially increasing expenditure.

Therefore, the correct answer is 1 and 3 only (Reducing revenue expenditure and Rationalizing subsidies).

There are two components of expenditure - plan and non-plan. Of these, plan expenditures are estimated after discussions between each of the ministries concerned and the Planning Commission.

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.

Non-plan capital expenditure mainly includes defence , loans to public enterprises,and loans to States, Union Territories and foreign governments.

The Plan and Non-Plan classification was done away with from fiscal 2017-18. Now emphasis is on Revenue and Capital expenditure.

In India, deficit financing is used to raise resources for meeting the government's expenditure requirements when its revenue or receipts fall short of its planned expenditures. In other words, deficit financing is a way for the government to finance its budget deficit to stimulate economic growth.

The external debt of India is the total debt the country owes to foreign creditors. The debtors can be the Union government, state governments, corporations, or citizens of India. The debt includes money owed to private commercial banks, foreign governments, or international financial institutions such as the International Monetary Fund (IMF) and World Bank.

- Commercial borrowings continued to be the largest component of external debt with a share of 37.4 per cent, followed by NRI deposits (24.1 per cent) and short-term trade credit (19.9 per cent).

- Statement 1 is incorrect: Non-Government Debt - 416.7 (US$ billion), Government Debt 104.5 (US$ billion).

- Statement 2 is also incorrect: US dollar-denominated debt continued to be the largest component of India's external debt with a share of 45.9 per cent at the end of December 2018, followed by the Indian rupee (24.8 per cent), SDR (5.1 per cent), yen (4.9 per cent) and euro (3.1 per cent).

Statement 1 is incorrect: Tax revenue as a percent of GDP in India has not steadily increased over the last decade. It has fluctuated — for instance, it rose during periods of strong economic growth but fell during years like 2019–20 and 2020–21 (due to slowdown and the pandemic). Hence, the trend is not steadily upward.

Statement 2 is incorrect: Fiscal deficit as a percent of GDP has also not steadily increased. It narrowed from around 4.5% in 2013–14 to about 3.4% in 2018–19, then spiked during the COVID-19 years (to around 9.2% in 2020–21) and has gradually declined since. Thus, there has been no steady increase over the decade.

Statement 1 is correct. The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report indeed recommended a debt-to-GDP ratio of 60% for the general (combined) government by 2023, with 40% for the Central Government and 20% for the State Governments. This recommendation aimed to ensure fiscal discipline and sustainability.

Statement 2 is not correct. The Central Government has domestic liabilities of 46.1% of GDP (2016-17) and as a percentage of GDP, States liabilities increased to 23.2 per cent at end-March 2016.

Statement 3 is correct. The Constitution of India empowers State Governments to borrow only from domestic sources (Article 293(1)). Further, as long as a State has outstanding borrowings from the Central Government, it is required to obtain the Central Government's prior approval before incurring debt (Article 293 (3)).

Statement 1 is Correct: Housing loans are credit obligations incurred by households. Since households are a primary component of the non-financial sector, their debt is classified as non-financial debt.

Statement 2 is Correct: Amounts outstanding on credit cards represent consumer debt owed by individuals (households) to banks or financial institutions. As this debt is owed by the non-financial sector, it is included in non-financial debt.

Statement 3 is Correct: Treasury bills (T-bills) are short-term debt instruments issued by the Government of India to manage its liquidity. The government is considered part of the non-financial sector, making its borrowings like T-bills and G-Secs part of non-financial debt.

The most inflationary method of financing a budget deficit is the creation of new money.

Option A is incorrect: Repayment of public debt involves the government transferring money back to the creditors (the public). This increases the liquidity and money supply in the hands of the public. However, it is generally less inflationary than printing new money because the funds used for repayment often come from tax revenues, which reduces the disposable income of the public elsewhere.

Option B is incorrect: Borrowing from the public involves a transfer of existing money from individuals and private institutions to the government. Since the total money supply in the economy remains the same (it just changes hands), this is considered the least inflationary way to finance a deficit.

Option C is incorrect: Borrowing from commercial banks can lead to an increase in the money supply if banks use their excess reserves to lend to the government, potentially leading to credit creation. While more inflationary than borrowing from the public, its impact is still significantly lower than the direct creation of new money.

Option D is correct: Creation of new money (often called deficit financing or monetization of debt) occurs when the central bank prints new currency to fund government expenditure. This directly increases the 'high-powered money' or monetary base in the economy. This expansion of the money supply, without a corresponding increase in the production of goods and services, leads to a sharp rise in price levels, making it the most inflationary option.

Statement 1 is correct: A portion of household financial savings in India does indeed go towards government borrowings. The government raises funds through various debt instruments like bonds and treasury bills. When households save money, they might invest it in these government debt instruments through banks or other financial institutions. This provides a source of funding for the government while offering a return to the investors (savers).

Statement 2 is correct: Dated securities are a major component of India's internal debt. These are essentially government bonds issued at market-determined interest rates through auctions. Investors, including households, banks, and financial institutions, can participate in these auctions and purchase dated securities.

Hence, both statements are correct.

Statement 1 is correct. Acquiring new technology - This is a capital expenditure. When a company acquires new technology (like software, machinery, or equipment), it's considered an investment that will benefit the organization for several years. The cost is added to the company's asset base and depreciated over its useful life.

Statement 2 is incorrect. Debt vs. Equity Financing - The way a company finances its expenditures (debt or equity) doesn't determine whether it's a capital or revenue expenditure. The nature of the expense itself matters more.

|Aspect|Capital Expenditure| Revenue Expenditure | |--|--|--| |Definition |Expenditure incurred for acquiring or improving fixed assets, which provide long-term benefits.|Expenditure that is incurred for routine operations and maintenance, providing short-term benefits.| | Purpose|To acquire, enhance, or extend the life of assets such as buildings, machinery, or equipment.| To meet day-to-day operational needs, like salaries, utilities, and maintenance.| |Impact on Assets | Increases the value of assets or creates new assets. |Does not increase the value of assets.| |Accounting Treatment |Recorded as an asset on the balance sheet and depreciated over time. |Recorded as an expense in the profit and loss statement for the current period.| |Time Horizon |Long-term benefit, typically spread over several years. |Short-term benefit, usually within the current year.| |Examples | Purchase of machinery, construction of buildings, land acquisition. |Salaries, wages, rent, repairs, and maintenance costs.|

Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003. The objective of the Act is to ensure inter-generational equity in fiscal management, long run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in fiscal operation of the Government. FRBM Act provides a legal institutional framework for fiscal consolidation.

The Act also requires the government to lay before the parliament three policy statements in each financial year namely 1. Medium Term Fiscal Policy Statement 2. Fiscal Policy Strategy Statement 3. Macroeconomic Framework Policy Statement