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Economic Bytes: Study of Budget (2019-20)

RBI report: States improve fiscal position, but with sharp cuts in capital expenditure – Study of Budget (2019-20)

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In News: Study of Budget (2019-20)

  • The RBI’s report on States Finances: A Study of Budgets of 2019-20 has been released.

Study of Budget (2019-20)
Study of Budget (2019-20)

Findings of Report: Study of Budget (2019-20)

  • The outstanding debt of states have risen over the last five years to 25 per cent of Gross Domestic Product, posing medium-term challenges to its sustainability.
  • States’ gross fiscal deficit (GFD) has remained within the FRBM threshold of 3 percent of gross domestic product (GDP) during 2017-18 and 2018-19.
  • This has, however, been achieved by sharp reduction in expenditures, in particular, capital expenditure.
  • For 2019-20, states have budgeted for a consolidated GFD of 2.6 percent of GDP with a marginal revenue surplus (as against revenue deficits in the previous three years).
  • However, States may have to take over higher losses of power distribution companies if they do not show a turnaround in their performance.

Impact of decline in capital expenditure:

  • Currently, states employ about five times more people and spend around one and a half times more than the Centre.
  • Sharp reduction in capital expenditure by states has potentially adverse implications for the pace and quality of economic development, due to the large welfare effects at the federal level.
  • It will lead to an erosion in the quality of physical and social capital infrastructure of the economy.
  • It can lead to a spiral of austerity, further impacting and deepening the economic downturn.
  • This would eventually influence further reductions in fiscal revenues and expenditure cut downs.

Reasons for low State revenues:

  • States’ revenue prospects are confronted with low tax buoyancies.
  • Shrinking revenue autonomy under the GST framework.
  • Unpredictability associated with transfers of IGST and grants.

Recommendations: Study of Budget (2019-20)

  • States need to combine efforts towards mobilizing higher revenues with strategies to maximize efficiency gains rather than mere increase in tax rates.
  • States need to gradually harness the GST database to expand the tax base.
  • States are also required to review their tariff policies relating to power and irrigation, while keeping an eye on the break-even user charges.

Types of Receipts:

  • Government receipts are divided into two groups—Revenue Receipts and Capital Receipts.
    1. Revenue Receipts:
      • Government receipts which neither create liabilities nor reduce assets are called revenue receipts.
      • These are current income receipts of the government from all sources.
      • Proceeds of taxes, interest and dividend on government investment, cess and other receipts for services rendered by the government fall under revenue receipts.
      • Revenue receipts are further classified into Tax Revenue and Non tax Revenue.
    2. Capital Receipts:
      • Government receipts which either create liabilities (e.g. borrowing) or reduce assets (e.g. disinvestment) are called capital receipts.
      • Examples of Capital Receipts which create liability are borrowing and raising of funds from Public Provident Fund and small savings deposits.
      • Examples of Capital Receipts which reduce assets are Disinvestment and Recovery of Loans.

Types of Expenditure:

  1. Revenue Expenditure:
    • An expenditure which neither creates assets nor reduces liability is called Revenue Expenditure.
    • Generally, expenditure incurred on normal running of the government departments and maintenance of services is treated as revenue expenditure.
    • It is a short period expenditure and recurring in nature which is incurred every year.
    • Examples of revenue expenditure are salaries of government employees, interest payment on loans taken by the government, pensions, subsidies, grants, rural development, education and health services, etc.
  2. Capital Expenditure:
    • An expenditure which either creates an asset (e.g., school building) or reduces liability (e.g., repayment of loan) is called capital expenditure.
    • This type of expenditure adds to the capital stock of the economy and raises its capacity to produce more in future. It is non-recurring in nature and is generally a long period expenditure.
    • Capital expenditure which leads to creation of assets are
      • Expenditure on purchase of land, buildings, machinery
      • Investment in shares, loans by Central government to state government, foreign governments
      • Acquisition of valuables.
    • Repayment of loan is also capital expenditure because it reduces liability.

Fiscal Deficit: Total income-total expenditure

  • Fiscal Deficit is the difference between the total income of the government (total taxes and non-debt capital receipts) and its total expenditure.
  • A fiscal deficit situation occurs when the government’s expenditure exceeds its income.
  • A recurring high fiscal deficit means that the government has been spending beyond its means.
  • A high fiscal deficit can also be good for the economy if the money spent goes into the creation of productive assets like highways, roads, ports and airports that boost economic growth and result in job creation.

FRBM Act:

  • The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003 to set targets for the government to reduce fiscal deficits, however, the targets were put off several times.
  • The FRBM Act is a fiscal sector legislation enacted by the government of India in 2003.
  • Aim: to ensure fiscal discipline by setting targets including reduction of fiscal deficits and elimination of revenue deficit, however, the targets were postponed several times.
Objectives of FRBM Act:
  • Ensure inter-generational equity in fiscal management.
  • Long run macroeconomic stability.
  • Better coordination between fiscal and monetary policy.
  • Transparency in fiscal operation of the government.
N.K. Singh Committee:
  • As the government believed the targets were too rigid, the government set up a committee in May 2016, under NK Singh to review the FRBM Act.
  • Committee recommendations: for centre
    1. The government should target a fiscal deficit of 3 percent of the GDP in years up to March 31, 2020 cut it to 2.8 percent in 2020-21 and to 2.5 per cent by 2023.
    2. To replace the FRBM Act, 2003, by a new Debt and Fiscal Responsibility Act.
    3. Advised on setting up of a Fiscal council to provide forecasts and analysis for fiscal deficit as well as advise the finance ministry on escape clauses.
  • Recommendations for states:
    1. For states, the FRBM panel has suggested a fiscal deficit glide path of 0.16 per cent per annum over a period of eight years.
    2. Further, the combined fiscal deficit of states needs to be brought down to 1.70 per cent by 2024-25.
    3. In case of debt to GDP ratio of states, the report said it ought to be reduced from 21.65 percent (in 2016-17) to 21.02 per cent in 2024-25.

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