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Fiscal Policy, Fiscal Rules & Managing Deficits/Debt

An introduction

Presentation

To

IRS officers

at

NACEN, Faridabad on 20th September, 2011

P.R. Devi Prasad IES

Director

Fiscal Policy Institute & Head Fiscal Policy Analysis Cell

Finance Department Government of Karnataka

Complexity and conflict of interests,

moral hazard

Citizen:

How to get more from Government by paying less

Vs.

Government:

How to give more to citizens

while taking more from them, and also

balancing special interest effect and

shortsightedness effect

Discussion point: Reactions to policy solutions & reforms

Perversity thesis: Futility thesis: Jeopardy thesis

Key Principles

• Nobody spends somebody else's money as carefully as he spends his own.

• Government has nothing to give anybody except what it first takes from somebody, and a government that’s big enough to give you everything you want is big enough to take away everything you’ve got.

Role of government ?

A provider or enabler… in

Creating Wealth?

Delivering Welfare?

Disclosing entitlements?

Defining empowerment?

Determining Property rights?

Qn: How significant is the initial endowment ?

Issues: Problem recognition, measurement, diagnosis, solution and implementation

Fiscal Policy

Represents formulation and implementation of government sector activities through budget

Achieves budget balance though size of government, type of budget financing and revenue & expenditure composition

Covers all levels of government including quasi government

Seeks internal & external balance, lowers debt, ensures long-term sustainability

Provides public goods; promotes private investment; engineers pro-poor growth

Reduces poverty and provides good governance

Issues: impact on interest rates, aggregate demand, output growth, competitiveness, credit rating, crowding out private sector;

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GDP

• GDP: Gross Domestic Product

– indicates annual national wealth production (value

added at every stage of production of goods & services: CSO brings out Advance, Quick and Quarterly estimates)

• Economic Growth

- GDP Growth: indicates how fast a nation is getting richer (Real Vs. Nominal Growth & WPI)

Issues: What causes higher GDP growth - Increase in Output:

What causes increase in Output – Increase in productivity & employment:. What causes increase in productivity – increase in efficiency.

What cause increase in efficiency - enhanced/effective technology & raised skills: What raises investment and skills - Creative people with money;

How to do that - Help more people to be creative & help them to have access to more money. (Note: The above slide and issues are framed using publicly available sources)

Y=C+I+G+(X-M)

What is Fiscal Space? Challenges to Fiscal Space ? Taxes: Driver growth or Hamper? Institutions: Driver growth or Hampers? Policies: Drive growth or Hamper? What is Fiscal Decentralization? GST : is it a case of Centralization ?

Issues: Stability, Simplicity, Transparency, Predictability, Certainty and Trust Reference: Report of the Task Force on Indirect Taxes 2002

Income Cycle …

Issues: Market Imperfections Vs. Competition Reforms: Product market, factor market, capital market

Households, Firms, Government, Rest of the World

Invest in Market friendly policies and regulate for fair competition

Some key Principles in Public Policy

• What belongs to you, you tend to take care of; what

belongs to no one or everyone tends to fall into disrepair.

• Sound policy requires that we consider long-run effects

and all people, not simply short-run effects and a few

people.

Key issues: Equity, Efficiency, Effectiveness, Economy, Entitlements

Ref: CAG’s Performance Audit Guidelines, and UK Government Green Book

If there is vagueness or subjectivity in the terms and conditions inviting tenders it may result

unequal and discriminatory treatment. It may violate doctrine of level playing field – Supreme Court of India on 17th Sept, 2007 in Reliance Energy case relating to Mumbai Trans-Harbour Sea link Projects

Should Equity be the Growth Policy Goal? If yes-

what are the issues in Policy design?

What are the implementation challenges?

How taxes policies can promote equity?

How to leverage Performance audit Reports for reforms?

What are the indices for quality of Growth?

The objective of

education is defined as acquiring skills

'to discover truth, to tolerate diversity, and

to practice fairness in assessing and relating to each other'

Flow of Funds from Centre to Schools

PT

Citizen CFI/Parlia

ment

Govt of Karnataka

CFK

SSA Donor

Projects Loans/grant

s

Zilla Panchayat

HRD MoF/CFI

Block

Drinking Water Supply Welfare

Min

NREG

Aided Schools

Flow of Funds-TAXES & Allocations: disbursements, sanctions, releases, expenditure, utilization, accounting & auditing

Govt Schools

Fees & Donations

Text Book Society etc.,

Anganwadi & Noon meal etc.,

School, PTA, TEACHERS, HEAD MASTERS

Student Boy

Student Girl

Student Special

RDPR

Education Dept

WCD

Treasury

Fiscal laws 1. Improve fiscal discipline with monitorable fiscal policy

2. Themselves don’t buy credibility or substitute for prudent fiscal policy or political commitment

3. Lead to non-monetization of debt

4. Contain short term horizon of political leadership

5. Promote policies have to be ex-ante and not ex-post

6. Escape clauses

7. Design features matter for effectiveness

8. Procedural and Numerical Rules

9. Incentives to deliver fiscal policy/discipline

10. Limits and disadvantages of numerical ceilings

11. Criticality of Transparency and accountability

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Issues: use public resources for productive purpose to generate future incomes; increase domestic savings and well developed capital markets to absorb deficit easily; maintain public debt at a level that is consistent with macro –economic objective.

15

Budget & the Constitution

While the following provide for

• Procedure in Parliament with respect to Estimates … 113

• Appropriation Bills … … … 114

• Supplementary, additional or excess grants … 115

• Votes on account, votes of credit and exceptional grants … 116

• Special provisions as to financial Bills … 117

• Consolidated Fund … … … 266

• Contingency Fund … … … 267

• Finance Commission … … … 280

• Expenditure defrayable by the Union out of its revenues … 282

• Laws/Rules for Custody, etc., of Consolidated Funds,

Contingency Funds and moneys credited to the

public accounts … … … 283

• Borrowing by the Government of India … 292

AFS- Anchor to all documents: Art 112 Trigger to All Documents

*Annual Financial Statement

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Legal Frame work

Borrowing by the Government of India - Art. 292

The executive power of the Union

extends to borrowing upon the security of the

Consolidated Fund of India

within such limits, if any,

as may from time to time be fixed by

Parliament by law and to the giving of guarantees

within such limits, if any,

as may be so fixed.

Constitution, FRBM Act, Public Debt Act, etc.,

India’s FRBM Act – Managing The Mandate

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Legislative Objective of fiscal responsibility

and budget management

“To Provide for the responsibility of the Central Government to

ensure inter-generational equity in fiscal management and

long-term macro-economic stability by achieving sufficient

revenue surplus and removing fiscal impediments in the

effective conduct of monetary policy and prudential debt

management consistent with fiscal sustainability through limits

on the Central Government Borrowings, debt and deficits,

greater transparency in fiscal operations of the Central

Government and conducting fiscal policy in a medium term

framework and for matters connected there with or incidental

thereto.”

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Budget

Making Budget

Management

Budget Review

FRBM Framework

F R B M Act

•(a) limits on Fiscal & Revenue Balance, debt & guarantees, •(b) Disclosures, (c) H1 performance indicators, (d) Transparency

A c c o u n t a b I l I t y* Disclosures

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FRBM Goals

• Reduce by >0.5% of GDP

• Reduce by >0.3% of GDP

• Assume < 0.5% GDP

• Reduce to “zero” by 2008-09 & build surplus later

• Reduce to 3% of GDP by 2008-09

Revenue Deficit

Fiscal Deficit

Contingent liabilities

Annual Medium Term

Triggers -Target time - Goals

Budget Circular - 29th February - FRBM Act - Annual Plans

Inputs Source Output presented in

1 SBE/ spending performance Line Ministries Demands for Grants

2 Pre-budget meetings Line ministries/ PC & CGA

Non-Plan in Demands for Grants

3 NTR/ guarantees/ assets profile/NTR arrears

Line ministries Receipts Budget statements

4 Plan allocations PC, DoE & Line ministries

GBS: Plan in Demands for Grants

5 State entitlements FC & DOE Transfers to States

6 Revenue receipts DoR (CBDT/CBEC) BE & RE

7 Debt/liability profile & Interest liability (instrument specific)

RBI, CAAA RE & BE, Receipts Budget statement

8 Resource Gap MoF Deficit targets

9 Fiscal Policy/ Strategy/GDP MoF FRBM Statements

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Budget & Debt Management

• Objectives – Minimize costs and risks in long & medium term

– Develop/ maintain efficient market for government securities

– Enlarge savings options

• Process – Preference to domestic debt (that finances about 90% of deficit)

– ‘No debt’ from external commercial sources

– Increasing reliance on marketable debt instruments

– Elongation of maturity of government securities

– Average tenor in 2005-06 is 15 years, longest tenor 30 years

– Institutional and administrative reforms to make debt market modern and deeper

for deficit financing

Fiscal Performance Before Crisis

: 22

Source: Budget at a glance 2007-08

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Costs

inputs

processes

outputs

outcomes

V

A

L

U

E

For

M

O

N

E

Y

Technically

efficient

E

C

N

O

M

I

C

A

L

L

Y

E

F

F

I

C

I

E

N

T

Effectiveness

Economy Traditional Budget

Output focused

Budget

Outcome focused

Budget

Budget performance Concepts, Systems/Management styles

Source; IMF Occasional Paper 245

Monetary Policy: objective & tools

• What determines Demand for Money?

• What determines supply of Money

• What determines Stock of Money

– Transactions and Store Value

• Liabilities of Central Bank

• Instruments – to increase costs, to limit business volume & operations

• Direct and Indirect instruments

• FRBM Act & Objective of blending monetary and fiscal

policies

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Transmission of Monetary Policy

25

Official

rate

Market

Rate

Asset

Prices

Expectations

and

Confidence

Exchange

Rate

Domestic

Demand

Net

external

demand

Total

Demand

Domestic

inflationary

Pressure

Import

prices

I

N

F

L

A

T

I

O

N

Sterilization, Market stabilization bonds, money supply, interest rates

Indian Structural Reforms Macro, Meso and Micro

1. Liberalization and regulation of specific markets

2. Trade Liberalization

3. Public Sector Management

4. Restructuring and privatizing utilities

5. Public expenditure reforms - economy, efficiency, transfers, user charges

6. Tax reforms

7. Public debt management

8. Monetary policy –Central bank independence

9. Financial Sector Reforms

10. Private and Public Governance Reforms

11. Decentralization and intergovernmental reforms

12. Civil Service Reforms

13. Land Reforms

14. Labour Reforms

15. Environmental Regulations

Issues: Is market system necessary for democracy: Democracy and Market system = Mass control over elite: Collective outcome Vs. Market outcome.

Government decision makers are like ordinary decision makers in market: influenced by their interests and bias but work in different incentive structure. ( eg: Distribution of income and power)

100 billion Indians’

approval to Deficit & Gross

Borrowings in BE ≈1/5th

of GDP

Leads to

Six months

Indicative Borrowing schedule

that helps

create

CFI

Dynamics of the debt redemption &interest payments by MoF from CFI

150 Primary Dealers to buy/redeem bonds (Assets)

RBI converges liquidity

needs with

bonds issue

schedule

Assumes annual

Costs of financing

the deficit ≈

difference in Gross

& Net

debt

Relevant Laws: Public Debt Act; RBI Act, SS Act, Govt. Sec. Act. FRBM Act,; Constitutional obligations to States & Public A/Cs; Notifications, MOUs with RBI

Debt

A N D

W & M Advances

Drawls from Cash Surpluses

Access MSS

NSSF Drawls

O P T I O N S

Domestic debt

I N S T R U M E N T s

<14 days TB

< 365 days TB

6 Years tenor

10 Years tenor

Special & Long Term

C R E a E S

P R I V A T T E

A S S E T S

T A K E S

O V E R

L I A B I L I T Y

Thus RBI’s CRR Policy & Liquidity Considerations

influence

i.e., G R O S S

D E B T

@ N E W

C O S T

Cash

Paid By

PDs

On

Net

Buy

B O N D S I S S U E D / R E I S S U E D

TO

I N T E R E S T

P A Y

O U T

A S

Charges/Fees

Charges/Fees

Charges/Fees

Interest

Interest

+

+

+

+

Balancing receipts & expenditure into

Pay

10% GDP as

T A X E S

To States’ Share

Net to’ Centre

Disbursements Through remaining

104 Demands

/ Grants in BE

≈ 4/5th of GDP

L E G E N D

CFI’’s pay out

relationship

Innovations

Instrument/ Fund

'Policy flow

PDs pay out

To NCCF

RBI/ PDs/ PSUs States

Pay NTR

We have to got to have…

…knowledge of what we intend to do & its related policy framework

…skills to apply that knowledge demonstratively

& productively …ability to understand implications of the skills

to measure the impact of those applications

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Thank You

Comments, questions, suggestions

d.prasad@nic.in

or

prdprasad@gmail.com

Recommended reading http://www.theamericanscholar.org/the-disadvantages-of-an-elite-education/ 29

Group discussion

1. We want more subsidies ?

2. We don’t want reforms ?

3. Learning from Key findings from Audit Reports on institutional issues of Indirect Taxes in various States and Centre.

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References

1. Micro Economics Public and Private Choice Gwartney, Stroup and Sobel

2. Report of the Task Force on Indirect Taxes, MoF 2002

3. Government Budgeting and Expenditure Controls by Premchand

4. Fiscal Policy: Fiscal Elements of Growth and Development G:20 & Republic of Turkey

5 Unlocking Public Value by Martin Cole Greg Parston

6. IMF Blog on PFM

7. C & AG website

8. www.adamsmith.org

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Core Budget Documents = 13+

1. Key to Budget Documents

2. Annual Financial

Statement

3. Budget at a Glance

4. Budget Speech

5. Budget Highlights

6. Action Taken on Budget

Announcements

7. Receipts Budget

8. Finance Bill

• Customs & Excise

Notifications

Presented by MoF and line Ministries

9. Explanatory Memorandum

10. Appropriation Bill

11. Demands for Grants • Exp. Budget Vol-1

• Exp. Budget Vol-2

12. FRBM Statements

• Macro-Economic framework for Year T+1

• Medium term fiscal policy for Years upto T+3

• Fiscal policy strategy for the Year T+1

• Deviations statement for Year T

13. Detailed Demand for Grants*

Pink Bold italics: Constitutionally mandated: Blue Bold: legally mandated White : supporting documents: * of respective ministries

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Few more Documents

• Economic Survey

• Supplementary Demand for Grants

• Finance Accounts

• FRBM Statements – Q4 of Year T-1

– Q3 of Year T

• Outcome Budgets

• Annual Reports

• Finance Commission Report

(Accepted Recommendations)

• Five Year Plan Documents (Annual Plans & Evaluation Reports) • RBI Reports relating to

–Credit /Policy

–Macroeconomic &

Monetary Developments

–State Budgets and

–Annual Report

• PSUs’ Annual Reports

Related* Relevant*

Discuss: *How & why to relate ? * How & when to look for relevance ? 33