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8/3/2019 Financial Admin.

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MONETARY POLICYMonetary Policy is essentially a Monetary Policy is essentially a programme of action

undertaken by the programme of action undertaken by the Monetary Authorities, generally the

Monetary Authorities, generally the Central Bank, to control and regulate the Central Bank, to

control and regulate the supply of money with the public and the supply of money with the

public and the flow of credit with a view to achieving flow of credit with a view to achieving pre-

determined macro-economics goals.pre-determined macro-economics goals.

At the time of inflation monetary policy at the time of inflation monetary policy seeks to

contract aggregate spending by seeks to contract aggregate spending by tightening the money

supply or rising tightening the money supply or raising the rate of return. the rate of return.

OBJECTIVES

-To achieve price stability by controlling inflation and deflation.

-To promote and encourage economic to promote and encourage economic growth in the

economy growth in the economy.

-To ensure the economic stability at full to ensure the economic stability at full employment orpotential level of output employment or potential level of output.

SCOPE OF MONETARY POLICY

The scope of Monetary policy depends on the scope of Monetary policy depends on two factors

two factors

1.Level of Monetization of the Economy

-In this all economic transactions are carried outing this all economic transactions are carried

out with money as a medium of exchange. This is with money as a medium of exchange. This is

done by changing the supply of and demand fordone by changing the supply of and demand for

money and the general price level. It is capable money and the general price level. It is capable

of affecting all economics activities such as of affecting all economics activities such as

Production, Consumption, Savings, Investment Production, Consumption, Savings, and

Investmentetc.etc.

2. Level of Development of the Capital Level of Development of the Capital Market

Some instrument of Monetary Policy is work some instrument of Monetary Policy are work

through capital market such as Cash Reserve through capital market such as Cash Reserve Ratio

(CRR) etc. When capital market is fairly developed then the Monetary Policy positively affects

TECHNIQUES OF MONITARY POLICY

OPEN MARKET OPERATION

.The open market operations are sale and purchase of government securities and Treasury Billsby the government securities and Treasury Bills by the central bank of the country. Central bank

of the country.

When the central bank decides to pump money into when the central bank decides to pump

money into circulation, it buys back the government securities, circulation; it buys back the

government securities, bills and bonds. Bills and bonds.


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The SLR is the proportion of the total deposits the SLR is the proportion of the total deposits

which commercial banks are statutorily required which commercial banks are statutorily

required to maintain in the form of liquid assets into maintain in the form of liquid assets in

addition to cash reserve ratio.

CREDIT RATIONING

When there is a shortage of institutional credit When there is a shortage of institutional credit

available for the business sector, the large and available for the business sector, the large and

financially strong sectors or industries tend to capture financially strong sectors or industries

tend to capture the lions share in the total institutional credit the lions share in the total

institutional credit.

As a result the priority sectors and essential industries As a result the priority sectors and

essential industries are of necessary funds are of necessary funds. Below two measures are

generally adopted: Below two measures are generally adopted:

Imposition of upper limits on the credit available to Imposition of upper limits on the credit

available to large industries and firms large industries and firmsCharging a higher or progressive interest rate on the Charging a higher or progressive interest

rate on the bank loans beyond a certain limit bank loans beyond a certain limit.

CHANGE IN LANDING MARGIN

The banks provide loans only up to a certain. The banks provide loans only up to a certain

percentage of the value of the mortgaged percentage of the value of the mortgaged property.

The gap between the value of the mortgaged The gap between the value of the mortgaged

property and amount advanced is called Lending property and amount advanced is called

Lending Margin.

The central bank is empowered to increase the central bank is empowered to increase the

lending margin with a view to decrease the bank lending margin with a view to decrease the

bank credit.

MORAL OBLIGATION

The moral obligation is a method of persuading the moral suasion is a method of persuading

and convincing the commercial banks to and convincing the commercial banks to advance

credit in accordance with the directives advance credit in accordance with the directives of the

central bank in overall economic interest of the central bank in overall economic interest of the

country.

Under this method the central bank writes letter .Under this method the central bank writes

letter to hold meetings with the banks on money and to hold meetings with the banks on

money and credit matters credit mattersREPO RATE AND REVERSE REPO RATE

Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. Banks

are always happy to lend money to the RBI since their money are in safe hands with a good

interest.

An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn

higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money

out of the banking system.


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The rate at which the RBI lends money to commercial banks is called repo rate. It is an

instrument of monetary policy. Whenever banks have any shortage of funds they can borrow

from the RBI. reduction in the repo rate helps banks get money at a cheaper rate and vice

versa. The repo rate in India is similar to the discount rate in the US

MONETARY POLICY: CHALLENGES/UNRESOLVED ISSUES -GENERAL1.INFLATION TARGETING

2. MONETARY AND FINANCIAL STABILITY of indian economy doubtful.

3.RBI CREDIBILITY to control inflation

4. REGULATORY & SUPERVISORY INDEPENDENCE not provided by government.

5. FISCAL POLICY DOMINANCE OVER MONETARY POLICY.

6.LACK OF RELIABLE MEASURES OF INFLATIONARY EXPECTATIONS

7. GREAT UNCERTAINTY (IGNORANCE?) ABOUT MONETARY POLICY

MONETARY POLICY CHALLENGES/UNRESOLVED ISSUES-SPECIFIC

1. APPROPRIATE RESPONSE TO STOCK MARKET VOLATILITY, ASSET'S PRICE DESTABILISE (ESP.

HOUSING SECTOR )

2.SPECIAL CONSIDERATIONS RELATING TO SENSITIVE SECTORS SUCH AS SMALL AND

MEDIUM SCALL INDUSTRIES , AGRICULTURE ETC.

3. TRADE BALNCE- FALLING DEMAND IN TRADING PARTNER

4. CURRENT A/C BALANCE

(i) IMPACT ON REMITTANCES BY NRI'S

(ii) LIKELY DECLINE IN IT EXPORTS AS MAJOR DEMAND FOR IT SERVICES IS FROM THE US (60%)

AND ESPECIALLY ITS FINANACIAL SECTOR

5 . CAPITAL A/C

(i) FII OUTFLOWS (FLIGHT TO SAFETY) FROM INDIA.

(ii) DRYING UP OF EXTERNAL COMMERRCIAL BANK LOANS

6.EXPERIENCED LOSSES AND LIQUIDITY PROBLEMS DUE TO THEIR EXPOSURE TODOMESTIC STOCK & CURRENCY MARKETS, WHICH HAVE PLUNGED IN THE WAKE OF THE

CRISIS

Monetary policy reforms

Monetary policy reforms are carried out by bringing about changes in interest rates, volume of

money supply etc. Again the motive of the reforms would determine the approach of the

government -

1. Interest rates - Interest rates can be brought down to boost the level of economic activity.

However, if a slow-down approach is adopted, then higher interest rates should be introduced

in the economy.2. Supply of Money - The money supply growth rate in the economy can be reduced to slow

down the economy or increased to boost it up.

3.Autonomy and freedome should provide to RBI and indian banks.

4. Government should provide positive fiscal policy back up to monetary policy.

5.Control infltionary pressure by simultaneously by monetary as well as fiscal policy

6.Steps should be take for current account deficit.


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7.More manufacturing exports encouraged with service exports.It exports should be diverted to

other countries.

8.Optimum control on FII outflow to india and encourage indian corporates for external

borrowing from international financial institutions.

FISCAL POLICYThe term "fiscal" has been derived from the Greek word 'fisc' for basket which symbolised the

treasury or the public purse. It simply means the exchequer or the government treasury. Fiscal

policy is that part of economic policy which is mainly concerned with the revenues and

expenditures of the government. It often includes public debt. Resources are raised through

taxes, non-tax sources and borrowings within the country and from abroad. The policies that

the government pursues in respect of raising revenues, levying taxes on income, commodities,

services, exports, imports and those relating to public expenditure have a tremendous impact

on the economy.

FISCAL POLICY-MEANING

Broadly speaking, fiscal policy is concerned with raising and spending financial resources and

public debt operations to influence the economic activities of the community in desired ways. It

is also concerned with the allocation of resources between the public and private sectors and

their use in accordance with national objectives and priorities. It aims at using its three major

instruments-taxes, public expenditure and public debt-as balancing factors in the development

of the economy.

According to Premchand "Formulation of fiscal policy presumes the identification and clear

recognition of the institutional aspects of government finance, such as tax systems, their

incidence and shifting, budget formulation and execution, and financial management ." Since

the state has come to occupy a pivotal role in the economic development of a country, fiscal

policy is being increasingly used, through a policy of taxation of Income, commodities, imports

and exports, a well designed policy of public expenditure and a policy of borrowings, to

influence the economic development of the country. Government budgeting is clearly the most

important instrument through which the fiscal policy is channeled. In fact, fiscal policy has

come to be identified with budgetary policy and the two terms are often used interchangeably.

OBJECTIVES OF FISCAL POLICY

The important objectives of fiscal policy include :

i) To increase the rate of capital formation In order to promote and sustain economic

development, the rate of capital formation has to bemuch higher than that prevailing in most


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of the underdeveloped countries.Ahigh rate of economic growth, sustained over a long period

is an essential condition for achieving a rising level of living. Since an increase in the rate of

growth does not come about automatically, the main objective of fiscal policy is to allocate

more resources for investment and to restrain consumption.

ii) Reduction in economic inequalities of income and wealth- Amajor contribution of fiscal

policy consists in minimising the adverse distributional impact of government policies. For

instance, in a developing country like India, the need for alleviation of poverty is self-evident.

There is, however, yet no evidence that the process of economic development has had any

positive economic impact on the impoverished classes. Mobilisation of resources for financing

the anti-poverty programmes, such as Integrated Rural Development Programme, Jawahar

Rozgar Yojana,MHNREGA,SGSY employment guarantee schemes, etc., is an important objective

of fiscal policy in India. In any case, in a democratic society political realities would not permit a

further widening of the distribution patterns than at present. Either by itself, or in conjunction

with other measures of social and economic reforms, the current fiscal policy has considerable

potential for reducing inequalities of income. CumuIative inequalities may take time to melt

away.

iii) Balanced growth-A primary feature of the economic scenario in developing countries is

their excessive dependence on agriculture rather than on industries and other non-agricultural

occupations. The process of economic development gives rise to a greater variety of economic

occupations, lesser dependence on land, and the need to provide employment to additional

labour which results from mounting population pressure. Balanced development not only

across income groups, but also across regions in the country can be achieved throughappropriate fiscal policy instruments. Another kind of balance is that between the public sector

and the private sector. There is no such thing as a pure market economy or a total centrally

planned economy. Once the appropriate mix and the economic role of the state have been

decided on, fiscal policy instruments are pressed into service to bring about the desired policy

changes.

iv) Economic and social overheads-Fiscal policy has to be so formulated that adequate

resources are available to the government for funding social expenditure which benefit the

poor. Heavy investments have to be made in infrastructure for sustaining growth in agriculture

and industry. The development of transport and communication, water management and

irrigation projects, large scale investments in health and education, cannot be left to the private

sector. Such investments are heavy and generally beyond the capacity of the private sector.

Privatesector is generally interested in projects with adequate and quick returns. The

government, therefore, has to have a fiscal policy which will alIow such investments in social


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overheads. Such investment will allow private capital to come in and by raising the productive

capacity and production, the government can generate profits.

v) Control of inflation -There are various causes of inflation. There can be too much money inthe hands of people and two few goods and services available for buying. An increase in

government expenditure results in an increase in payment of salaries, wages, purchase of

goods and services. This puts more income in the hands of the people. An increase in wages of

industrial workers also increases money income. Wages also constitute costs of inputs. If costs

go up, so do prices. This is cost-push inflation. Thus inflation results either because there is too

much demand (because of increased purchasing power) for too few goods or because the costs

of inputs having gone up the prices rise. An appropriate fiscal policy can help in controlling

inflation. A noninflationary financing of planned development will require a greater reliance on

surplus generated by the budget and public sector undertakings and a reduced dependence onborrowed funds.

vi) Progressive tax structure

Taxes and subsidies have direct consequences for the poor to the extent that they bear the

burden of taxes or benefits from the subsidies. In a developing country like India, the tax

structure relies heavily on indirect taxes. This is not surprising, given the stage of development,

low income levels of the majority of the people and the scope for commodity taxes offered by

the growth of industry and trade. The government should try to increase the scope of the

indirect tax system, both through low tax rates on essential commodities and throughsubsidised distribution of foodgrains, edible oils and sugar. At the same time, an effort has to

bemade to increase the share of direct taxes in total tax revenue over a period of time, so that

the fiscal system as a whole becomes progressive. What matters, however, is not the tax rates

on paper, but the actual collections and their incidence. Fiscal policy must, therefore, ensure

that taxes, as levied, are fully collected and strong action is taken to curb tax evasion.

Measures To Overcome Fiscal Imbalance In India

Fiscal imbalance takes place due to excess of government expenditure over revenue. To

overcome the deficit, government resort to borrowings. This further aggravates the situation of

debt servicing.Therefore there is a need to correct and overcome the fiscal imbalance.

The fiscal imbalance can be corrected by adopting following two methods:-

1.Reducing Government Expenditure.

2.Raising proper financial resources (funds) for productive purposes.

A. Reduce Government Expenditure

Suggested ways by which government's expenditure can be reduced are :-


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1. Reduction in Interest Burden

Over the years, there has been considerable increase in Government borrowings. As a result,

the interest payment of the Government has increased considerably. The interest payment has

been the single major component of revenue expenditure of both the state and central

government. For instance, the interest payment of the central government of India has

increased from Rs.21,500 crores in 1990-91 to Rs.1,39,823 crores in 2005-06, which works outas 33% of the total revenue expenditure. Therefore, there is a need to reduce government

borrowings so as to reduce interest burden, which in turn would reduce Government

expenditure.

2. Reducing Subsidies

The government of India has been providing subsidies on a number of items such as food,

fertilizers, education, interest to priority section, and so on. Because of the massive amounts of

subsidies, the government expenditure has increased over the years. Therefore there is need to

reduce government subsidies.

3. Reduction in Government Overheads

The public sectors and government departments are subject to high overheads. There is often

overstaffing due to poor manpower planning. Also, there are huge overheads in respect of

maintenance of machines, consumption of energy, and so on. Some of the overheads can be

easily reduced. Therefore, there is a need to reduce overheads, wherever possible, in order to

reduce Government expenditure.

4. Closure of Sick Units

The government needs to close down the sick public sectors or disinvest them. Closing down

non-viable sick units would enable the government to save their valuable resources which

otherwise would have been used for such sick units. Disinvestment would generate additional

revenue to the government. In India, the disinvestment process was started in 1991-92.

However, the process of disinvestment is very slow in India due to political compulsion.

B. Raise Government Funds

Suggested ways by which government's funds can be raised are :-

1. Collection of user charges

The government should take adequate measures to collect user charges from the consumer in

respect of public utilities like water supply, electricity, irrigation, transport, etc. The user

charges are subsidized in case of certain services.

2. Improvement in Performance of PSUs

Due to poor performance of PSUs, the government loses a good amount of revenue by way of

dividends. Therefore, the government should make every effort to improve efficiency and

performance of public sector units (PSUs), which in turn would enable the government toobtain more funds for productive expenditure.

3. Proper Mobilization of Tax Resources

In India there is a good deal of tax evasion both of direct and indirect taxes.

The tax evasion is due to the following reasons :-

-High tax rates,

-Too many formalities and documentation work,

-Inefficient and corrupt tax administration.


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Therefore, the government should make proper efforts to simplify the tax procedures, and at

the same time take appropriate measures to reduce tax evasion.

4. Market oriented development

Market oriented development will stimulate demand and encourage growth. Incentives are

given through the fiscal policy to encourage the private sector investments. The areas of

operation of public sector enterprises have been reduced. This will reduce governmentsborrowing and its dependence on household savings.

New Fiscal Policy of India

In view of the economic liberalization in the recent years, certain themes have been

emphasized in the New Fiscal Policy of India. They are :-

1.Simplification of tax structure and laws.

2.Reasonable direct taxes and better administration.

3.Stable tax policy environment.

4.Weightage to resource allocation and equity consequences of taxation.

5.More reliance on fiscal and financial instrument in managing the economy.

6.Better links between fiscal and monetary policy.

7.Strengthening methods of expenditure control.

The Fiscal measures adopted by the Govt of India would reduce the inflation, reduce the deficit

in balance of payments and promote growth and unemployment. The effects of the new fiscal

policy are likely to be favourable to the indian economy.

PUBLIC DEBT AND BORROWINGAs said earlier, the government finances its expenditure through conventional sources like

taxes. public borrowing or printing money. With the government undertaking programmes of

planned economic development on a large scale, it is not possible to meet the relatedexpenditure either entirely through taxation or creation of new money. There is a certain limit

beyond which revenue from taxation cannot be raised as it would affect the level of

investment, production in the country and people's paying capacity. Also financing the

programmes through creation of new money beyond a certain level becomes inflationary.

Hence resort to public borrowing as a method of resource mobilisation has become an

increasing phenomenon in present times. Public borrowing helps in discouraging unproductive

expenditure and diverts the savings of the people for capital formation, financing new

developmental projects etc.

In this section, we shall discuss the meaning of public debt. reasons for resorting to ' public

borrowing and types of public debt. The unit highlights the elements of public debt

management, trends and structure of public debt in India and the role of Reserve Bank of India

in public debt management.


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PUBLIC DEBT - CONCEPT AND CAUSES

Modern fiscal policy endorses unbalanced government budgets for purposes of stimulating

economic growth and stabilising economy, its application leading to a growing public debt.

Growth of public debt has been quite substantial in almost all developing economies in recent

years.

Public debt in simple words means debt incurred by the government in mobilizing savings of

the people in the form of loans, which are to be repaid at a future date with interest. Public

debt can be both internal as well as external. According to Richard Musgrave and Peggy

Musgrave, "(Public) borrowing involves a withdrawal I made in return for the government's

promise to repay at a future date and to pay interest at the interim".

The concept of public borrowing as such was condemned earlier by classical economists like

Hume and Adam Smith who considered that it would compel the government to tax the public

and hence lead to disequilibrium in the economic system. Later the Great Depression of 1929

brought about a marked change in economic thinking of which J.M. Keynes was the pioneer. It

was felt that public debt would raise the national income, lead to effective demand in the

economy, increase the employment and output. hence it was after the second world war that

public borrowings came to occupy a prominent place in the budgets of governments.

Having discussed the concept of public debt, now let us highlight the causes for publicborrowing.

a) A considerable portion of the public debt is attributable to the sharp increases in government

outlays in public sector projects. Building up the economic infrastructure like railways, roads,

bridges, power plants etc. that provide the base for economic development, requires huge

investments which the government cannot finance just through taxation.

b) Another reason for the growth in public debt is due to both the Central and state

governments lending significant amounts of capital funds to the private sector for investment in

planned development projects.

c) Public borrowing is resorted to for meeting temporary as well as long-term deficits. It is

required to meet the current deficits in budget when the revenues are insufficient to meet the

expenditure. Also in times of war, or economic crisis, or other unexpected emergencies, the

increase in governmental activities result in increasing expenditure that make the government

resort to public borrowing.


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In recent years, factors-like increase in prices, enlargement of administrative services,

increasing expenditure on defence, wages and dearness allowances etc., have also contributed

to increase in public debt.

CLASSIFICATION OF PUBLIC DEBT

As said earlier, one method by which a public authority may obtain income is by borrowing. The

proceeds or whatever is collected from such borrowing form part of public receipts. On the

other hand the payment of interest op and the repayment of the principal of the public debts

thus created form part of public expenditure. Public debt car; be classified in many ways.

Let us now discuss some important classifications :

1) Reproductive and Unproductive Debt

A distinction is, often, drawn between 'reprodu tive debt' and dead weight debt or

unproductive debt. The former is a debt whith fully covered or balanced by the possession of

assets of equal value. These debts are incurred generally for the construction of such capital

assets which yield revenue to the government. In case any debt is incurred to meet expenditure

on irrigation, railways etc., the income derived from the creation of such assets can be used to

repay the debt. With regard to reproductive debt, the interest and sinking fund on it (about

whilch we will discuss later) is normally paid out of income derived by the public authority,from

the ownership of its property or the conduct of its enterprises. And here it is a good working

rule that the debt should be repaid within the physical lifetime of the corresponding asset.

Unproductive or dead weight debt is that debt which is incurred to cover any budgetary deficits

or for such purposes as do not yield any income to the government in times of war for example.

The interest and sinking fund, if any, on this type of debt must be obtained from some other

source of public income, generally from taxation and, since there is no corresponding asset

created, there is no rule regarding the period of repayment.

2) Voluntary and Compulsory Debt

Public debts are incurred through public loans. There are two types of loans -voluntary and

compulsory. Voluntary loans are those regarding which people are free to subscribe to

government's securities whenever they are floated. The chiefadvantage of a voluntary load, as

compared with taxation is, that, in the case of former, people are free, according to their

circumstances and inclination, to subscribe as much or as little as they please. Compulsory loan

is a rarity in modern public finance, though, in emergencies like war, famine etc., government

enforces borrowing through legal compulsion to secure required amount of funds. This is also

resorted to at times to curb inflationary tendencies in the economy.


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3) Internal and External Debt

Public debt may be internal or external. It is internal if subscribed by persons or institutions

inside the country. An internal loan only involves transfers of wealth within the borrowingcommunity which in this case is the same as the lending community, In cage of external loan, it

involves, firstly, a transfer of wealth from the lending to the borrowing community, when the

loan is raised and secondly, a transfer in the reverse direction, when the interest is paid or

principal is repaid.

4) Long-term and Short-term Debt

Public debt may either be for a long-term or for a short-term. This is a distinction of degree. The

distinction often drawn between "funded" and "floating or unfunded" debt is roughly

equivalent to that between long and short-term debt. Funded or long-term debts are repayableafter a year while unfunded debts are generally incurred for a short-term and must be repaid

within a year. It includes the treasury bills which are issued for a currency of ninety-one-days,

ways and means advances from the Reserve Bank of India (less than three months) etc.

5)Deficit Financing- Deficit financing in Indian context occurs when there'are budgetary deficits.

Let us now discuss the meaning of budgetary deficit. Budgetary deficit refers to the excess of

total expenditure (both revenue and capital) over total receipts (both revenue and capital). In

the words of the First Plan document, the term 'deficit financing' is used to denote the direct

addition to gross national expenditure through budget deficits, whether the deficits are on

revenue or on capital account. The essence of such a policy lies, therefore, in government

spending in excess of the revenue it receives in the shape of taxes, earnings of state

enterprises, loans from the public, deposits and funds and other miscellaneous sources. The

government may cover the deficit either by running down its accumulated balances or by

borrowing from the banking system (mainly from the Central Bank of the country) and thus

'creating money'. Thus, the government tackles the deficit financing through approaching the

Central Bank of the country i.e. Reserve Bank of India, and commercial banks for credit and also

by withdrawing its cash balances from the Central Bank.

Public Debt In India

During recent years, public debt in India has been growing at an alarming rate. The under

developed nature of the economy & institutional credit deficiencies makes the financing of

economic development a complicated problem. Hence the government has to play a key role in

stimulating the rate of capital formation & in promoting the economic development of the

economy.So public debt can be used by the government as means for mobilising the resources.


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The following table indicates the composition of public debt of the Central Government of

India.

From the above table, it is clear that the Central Government of India's debt has increased by

over 7 times between 1990-91 and 2005-06. Apart from internal debt, there are also internal

liabilities of the Central Government in the form of small savings of the public, provident funds,

and reserves funds and deposits of Government departments.

A. Internal Debt

The internal debt is a major component of public debt of the central government of India.

The following are the various components of internal debt.1. Market Loan

These have a maturity period of 12 months or more at the time of issue and are generally

interest bearing. The government issues such loans almost every year. These loans are raised in

the open market by sale of securities or otherwise. Total market loans as at the end of March

2005 are estimated at Rs. 7,58,999 crores.

2. Bonds

The Government borrows funds by way of issue of bonds. The government obtains funds

through the issue of bonds such as National Rural Development Bonds, Central Investment

Bonds. The bonds are issued at different maturity periods, which may range from 3 years to 10

years period. They provide medium-term to long-term funds to the government.3. Treasury Bills

A major source of short-term funds for the government is obtained by issue of treasury bills. At

present, government issues 91 day and 364 day treasury bills. The treasury bills are purchased

by commercial banks and others. The amount of debt as a result of Treasury bills decreased

from Rs. 64,760 crores in 1997 to Rs. 7,184 crores as at the end of March 2006.

4. Special Floating and Other Loans

These represents India's contribution towards share capital of international financial

institutions like IMF, World Bank, International Development Agency and so on. These are non-

negotiable and non-interest bearing securities. The Government of India is liable to pay the

amount at the call of these institutions. Accordingly, it is a short-term debt upon the

Government of India. At the end of March 2006, special and other loans rose to Rs. 21,631crores.

5. Special securities issued by RBI The government obtains temporary loans for a period of

maximum 12 months from RBI and issues special securities, which are non-negotiable and non-

interest bearing. Such securities provide short term funds to the Government.

6.Ways and Mean Advances


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The Government of India obtains ways and means advances from the Reserve Bank of India to

meet its short period expenditure. These debts are purely temporary in nature and are usually

repaid within three months.

7. Securities against small savings

Since 1999-2000, under the new accounting system, national small savings have been

converted into the Central Government securities. As a result there has been a sharp increasein internal debt and corresponding decline in small savings. At the end of March 2006,

securities against small savings amounted to Rs. 2,06,631 crores.

B. External Debt

External debt refers to the liabilities of the Indian Government, public sector, private sector and

financial institutions to overseas parties.

The government of India has raised foreign loans from U.S.A, U.K, France, U.S.S.R, Japan, etc.

External Debt rose from Rs. 31,525 crores in 1990-91 to Rs. 68,392 crores in 2005-06.

The external debt can be broadly divided into two groups :-

A. LONG TERM LOAN

1.Multilateral borrowings,

2.bilateral borrowings

3.Loans from IMF, World Bank, etc.

B. Short term debt :

It is to be noted that the overall external debt of India comprises of Government debt and Non-

government debt. The Government debt is owed by Govemment authorities, both Central and

State Governments, whereas the non-Government debt is owed by private parties in India. In

terms of composition, India's external debt has shifted in favour of private debt over the last

decade.

C. Other Internal Liabilities

The government does not include liabilities under Public Debt. However, the government is

liable to make repayment of these liabilities.1. Small Savings

In recent years small savings have increased due to rising money income in the economy.

Recently the Government of India launched a number of small savings instruments. These

include 9% Relief Bonds 1987, Kisan Vikas Patras, Indira Vikas Patras, etc.

The outstanding amount of small savings increased from Rs. 2,209 crores in 1971 to Rs.

4,18,110 crores at the end of March, 2006.

2. Provident Funds

Provident funds are divided into two categories :-

Employee Provident Funds meant for employees.

Public Provident Funds meant for general public.Outstanding amount under provident fund stood Rs. 66,217 crores at the end of March 2006.

3. Other accounts

Other accounts include Postal Insurance and Life Annuity Fund, Borrowings against Compulsory

Deposits, Income Tax Annuity Deposit, Special Deposit of Non-Government Provident Fund and

Outstanding Amount.

Other accounts were Rs. 1,76,649 crores at the end of March 2006.

4. Reserve Funds and Deposits


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Reserve Funds and Deposits are divided into two categories :-

Interest bearings and

Non-interest bearings.

They include depreciation and reserve funds of Railways, Department of Post,

Telecommunication, Deposits of Local Funds, Departmental and Judicial Deposits, Civil

Deposits, etc.Reserve Funds and Deposits increased to Rs. 1,01,170 crores at the end of March, 2006.

Conclusion On Public Debt In India

The main reason for increase in internal public debt in India during 1961-2004 was the

requirement of funds for financing various developmental programmes as both tax and non-tax

revenues were totally inadequate to finance the government expenditure.

The external public debt in India Increased significantly during 1961-2004 as it was utilized to

make import payments and solve balance of payment problems.

The tremendous rise in total public debt in India during 1991-2004 provides an alarming signal

to Indian economy. There is an urgent need to manage public debt in India.PUBLIC DEBT MANAGEMENT

Public debt occupies the minds of politicians, editorial writers, citizens and economists.

Intuitions tell us that we would be better off without the debt just as we would wish to be free

of personal debts. Yet to sort out the real burden from the fancied requires the most careful

economic analysis. It is all the more important because the burden of public debt can be shifted

wholly or in substantial part from the present to the future generation. The burden of public

debt is not something which can be thrown backwards and forwards through time and made to

fall, at will, wholly on one generation or wholly on another.

Can large public debt lead to default or bankrupt the government? Default occurs when aborrower fails to meet its financial commitments. Bankruptcy exists when a borrower's debt far

exceeds its ability to meet obligations. The government will neither default nor face bankruptcy

since it has .the power to tax and print money. Suppose the government has no tax revenue to

meet interest payment on its debt, it can secure whatever funds it needs by raising taxes.

Alternatively, since it is the sole issuer of paper currency, it can print additional paper currency

and use it to meet its interest payments. Thus with virtual unlimited sources of funds, the

government is not prone to default or bankruptcy.

In practice, as a portion of debt falls due each month, government does not usually cut

expenditure or raise taxes to provide funds to retire or repay the maturing bonds. Rather, the

government simply refinances the debt, i.e. it sells new bonds and uses the proceeds to pay off

holders of the maturity bonds. Hence public debt management becomes a crucial task or

responsibility of the government. Public debt management refers to the task of determining, by

the fiscal and monetary authorities, the size and compositionof debt, the maturity pattern,

interest rates, redemption of debt etc. Keeping in view the increasing magnitude of public


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borrowing both internal and external, about which we will discuss in subsequent sections, the

extent to which the government can mobilise funds from public depends upon the skilful public

debt management.

In this task, various aspects need to be kept in view like lowering the rate of interest, adjusting

the length of the maturity of debt, providing adequate funds for economic development etc.

For example, if both the central and state governments decide to go in for public borrowing,

details need to be worked out regarding the amount, interest rates and other terms and

conditions accompanying the loans. In India, this task of bringing about the coordination is

achieved throughsthe Reserve Bank of India which is the central monetary authority. Elements

of public debt management Let us now discuss some of the important methods usually adopted

for the retirement of public debt.

These include the following :

i) Refunding

ii) Conversion

iii) Surplus Budget

iv) Sinking Funds

v) Terminable Annuitibti

v) Additional Taxation

vii) Capital levy

viii) Surplus balance of payments

i) Refunding of debt implies the issue of new bonds and securities by the .government in order

to repay the matured loans. In the refunding process, usually short-term securities are replaced

by long-term securities. Under this method the money burden of debt is not relinquished but iS

accumulated owing to the postponement of debt redemption.:

ii) Conversion of public debt implies changing the existing loans, before maturity, into new

loans at an advantage. In fact, the process of conversion consists generally in converting or

altering a public debt from a higher to a lower rate of interest. Now, when the rate of interest

falls, it may convert the old loans into new ones at a lower rate, in order to minimise the

burden. Thus the obvious advantage of such conversion is that it reduces the burden of interest

on the tax-payers. The success of conversion, however, depends upon (i) the credit worthiness

of the government, (ii) the maintenance of adequate stock of securities, (iii) the efficiency in


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managing the public debt. The difference between refunding and conversion is that in the case

of the latter, there can be : a change in rate of interest and other terms.

iii) Quite often, surplus budget (i.e., by spending less than the public revenue obtained) may be

utilised for clearing of public debts. But in recent years, due to ever-increasing public

expenditure, surplus budget is a rare phenomenon. Moreover, heavy taxes have to be imposed

for realising a surplus budget, which may have adverse consequences. Or when public

expenditure is reduced for creating surplus budget, a deflationary bias may develop in the

economy. Hence this method is not considered suitable for retirement of any debt.

iv) A sinking fund is created by the government and it is gradually accumulated every year by

setting aside a part of current public revenue to be deposited in the fund in such a way that it

would be sufficient to pay off the funded debt at the time of maturity. Perhaps, this is the most

systematic and the best method of redemption. Under this method, the aggregate burden of

public debt is least felt, as the burden of taxing the people to repay the debts is spread evenlyover a period of time. Accumulation of the fund inspires confidence among the lenders and

thereby the credit-worthiness of government increases. A sinking fund is however, a slow

process of debt redemption. Moreover, during an emergency or financial stringency, the

government is tempted to encroach upon such funds.

v) Terminable Annuities of debt redemption is similar to that of sinking fund. Under this

method, the fiscal authorities clear off or repay a part of the public debt every year by issuing

terminable annuities to the bond holders which mature annually. This is the method of

redeeming debt in instalments. By this method the burden of debt goes on diminishing annually

and by the time of maturity, it is fully paid off.

vi) The simple method of debt repayment is to impose new taxes and get the required revenue

to repay the principal amount of the loan as well as interest. This method causes redistribution

of income by transferring the resources from taxpayers to the hands of bond holders. It may

also impose burden on future generation if new taxes are levied to repay the long-term debts.

vii) Capital levy is strongly recommended by Dalton as a method of debt redemption with the

least real burden on the society. Capital levy refers to a very heavy tax on property and wealth.

It is a once for all tax on the capital assets and estates. It is generally imposed after a war to

repay unproductive war debts.

viii) The retirement of external debt, however, is possible only through an accumulation of

foreign exchange reserves. This necessitates creation of a favourable balance of payments by


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the debtor country by augmenting its exports and curbing its imports, thereby improving the

position of its trade balance.

Thus the debtor country has to concentrate on the expansion of its export sector industry.

Further, loans raised must be productively utilised, so that they may become self liquidating,

posing no real burden to the country's economy. In developing economies, where external debt

has increased tremendously, it is necessary that its burden is reduced by changing the terms of

repayment or rescheduling the debt.

PUBLIC DEBT AND ECONOMIC DEVELOPMENT AND INFLATION

The existence of a large public debt does Dose real and potential problems Externallv held debt

is obviously a burden. The payment of interest and principal require the transfer of a portion of

real output to other nations.

When a developing economy borrows abroad to build a dam or when a state issues to build aschool, it acquires an external debt that has to be repaid at some future date. Just as in the case

of an individual, the borrowing increases the total resources available initially, but reduces the

resources available in the future. To meet the interest and repayment charges owed to the

outside world, the government must reduce future public spending or raise taxes and thereby

reduce private spending. In each case, it cuts total internal resource use. In effect, the

borrowing simply makes the resources that were available earlier in exchange for the

commitment to pay interest. The initial increase in total available resources is made possible by

borrowing done outside the community. Similarly, interest and repayment means that the

community gives up resources to the outside world later.

When government borrows within the country, total resources available to the country as a

whole are not increased. The resources are simply transferred from bond payers i.e. people to

the government. Similarly, the interest and repayment charges do not transfer resources

outside the country but only transfer them from the taxpayer to the bondholders.

One burden of a public debt is unambiguous. Extra taxes have to be imposed to finance the

interest payments. These taxes lead to some loss of real output because of their distorting and

disincentive effects. Even though the redistribution of income from the taxpayers to the

bondholders is only a transfer payment, it does contribute to the negative effects of the taxsystem. Thus dead weight loss is borne year after year as the interest payments continue to be

met.

As the debt financing of public spending leads to the decline in investment, there would be

another unambiguous loss of output. Future generation would inherit a small stock of capital,

an economy with a smaller capacity to produce, hence a smaller output. Debt financing also


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reduces private investment. Firstly under conditions of full employment and with an unchanged

monetary policy, when the government borrowing is competitive with private borrowing,

interest rates will be raised by the deficit, and investment will be reduced. This is usually called

"Crowding out Effect" (Government borrowing will increase the interest rate and reduce

private investment). Secondly, investment may also be reduced by the presence of an existingpublic debt. Consumers may consider their bond holdings to be a part of their wealth which

would make them feel wealthier, raise their consumption, and cut their saving. Further, the

higher taxes to cover the interest must have some negative influence on investment. Finally,

the existence of large debt may have psychological influence on business behaviour. If people

really get alarmed over the national debt, the loss of confidence may curtail their investment.

The significance of this psychologicai factor is difficult to evaluate.

The average citizen fears the debt mainly as a source of inflation. The debt represents past

outlays that were not matched by taxes, hence it measures past government claims to

resources that it could not pay for. If government e'ngages in debt financing when the economy

is already at full employment, existence of a large public debt tends to shift the consumption

schedule upward. This shift will be inflationary. Furthermore, government bonds can be

converted into money easily and will have little or no, risk of loss. Government bonds,

therefore, constitute a potential backlog of purchasing power which can add materially to

inflationary pressure_s. During periods of inflation, it is very tempting for consumers to utilise

this reserve of purchasing power in an attempt to beat rising prices. Such an attempt to tackle

inflation will cause more inflation.

Until now we have seen only one side of the coin. There is another side to the public debt i.e.,the positive role of public debt in economic development. Both public and private debts play a

positive role in a prosperous and growing economy.'As economy expands, so does saving.

Modern employment-theory and fiscal policy tell us that, if aggregate demand is to be

sustained at a high level of employment, this expanding volume of saving or its equivalent must

be obtained and spent by the consumers, business houses or government. The process by

which saving is transferred to spenders is debt creation. Whenever government issues bonds,

since these are highly liquid and risk free securities, they make an excellent purchase for small

and conservative savers. To the extent that the availability of bonds encourage saving, more

resources are freed for investment and economic growth tends to be enhanced,

TYPES OF BUDGETS

Line-ItemBudgeting

Line-item budgeting is still the most widely used approach in many organizations, including

schools, because of its simplicity and its control orientation. It is referred to as the "historical"

approach because administrators and chief executives often base their expenditure requests on


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historical expenditure and revenue data. One important aspect of line-item budgeting is that it

offers flexibility in the amount of control established over the use of resources, depending on

the level of expenditure detail (e.g., fund, function, object) incorporated into the document.

The line-item budget approach has several advantages that account for its wide use. It offers

simplicity and ease of preparation. It is a familiar approach to those involved in the budget

development process. This method budgets by organizational unit and object and is consistentwith the lines of authority and responsibility in organizational units. As a result, this approach

enhances organizational control and allows the accumulation of expenditure data at each

functional level. Finally, line-item budgeting allows the accumulation of expenditure data by

organizational unit for use in trend or historical analysis.

Although this approach offers substantial advantages, critics have identified several

shortcomings that may make it inappropriate for certain organizational environments. The

most severe criticism is that it presents little useful information to decisionmakers on the

functions and activities of organizational units. Since this budget presents proposed

expenditure amounts only by category, the justifications for such expenditures are not explicit

and are often unintuitive. In addition, it may invite micro-management by administrators and

governing boards as they attempt to manage operations with little or no performance

information. However, to overcome its limitations, the line-item budget can be augmented with

supplemental program and performance information.

PerformanceBudgeting

A different focus is seen in performance budgeting models. In a strict performance budgeting

environment, budgeted expenditures are based on a standard cost of inputs multiplied by the

number of units of an activity to be provided in that time period. The total budget for an

organization is the sum of all the standard unit costs multiplied by the units expected to be

provided. Although this strict approach may be useful for certain types of operations, manyorganizations require a more flexible performance approach. For example, expenditures may

be based simply on the activities or levels of service to be provided and a comparison of

budgeted and historical expenditure levels.

The performance approach is generally considered superior to the line-item approach because

it provides more useful information for legislative consideration and for evaluation by

administrators. Further, performance budgeting includes narrative descriptions of each

program or activity-that is, it organizes the budget into quantitative estimates of costs and

accomplishments and focuses on measuring and evaluating outcomes. Finally, the performance

approach eases legislative budget revisions because program activities and levels of service may

be budgeted on the basis of standard cost inputs.However, performance budgeting has limitations owing to the lack of reliable standard cost

information inherent in governmental organizations. Further, the performance approach does

not necessarily evaluate the appropriateness of program activities in relation to reaching an

organization's goals or the quality of services or outputs produced. Consequently, the

performance approach has become most useful for activities that are routine in nature and

discretely measurable (such as vehicle maintenance and accounts payable processing)-activities

that make up only a relatively modest part of the total educational enterprise. But in sum,


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performance budgeting may offer considerable enhancement to the line-item budget when

appropriately applied.

Program and Planning (Programming) Budgeting (PPB)

Program budgeting refers to a variety of different budgeting systems that base expenditures

primarily on programs of work and secondarily on objects. It is considered a transitional formbetween traditional line-item and performance approaches, and it may be called modified

program budgeting. In contrast to other approaches, a full program budget bases expenditures

solely on programs of work regardless of objects or organizational units. As these two variations

attest, program budgeting is flexible enough to be applied in a variety of ways, depending on

organizational needs and administrative capabilities.

Program budgeting differs from approaches previously discussed because it is much less

control- and evaluation-oriented. Budget requests and reports are summarized in terms of a

few broad programs rather than in the great detail of line-item expenditures or organizational

units. PPB systems place a great deal of emphasis on identifying the fundamental objectives of

a governmental entity and on relating all program expenditures to these activities. This

conceptual framework includes the practices of explicitly projecting long-term costs of

programs and the evaluation of different program alternatives that may be used to reach long-

term goals and objectives. The focus on long-range planning is the major advantage of this

approach, and advocates believe that organizations are more likely to reach their stated goals

and objectives if this approach is used.

However, several limitations exist in the actual implementation of this approach, including

changes in long-term goals, lack of consensus regarding the fundamental objectives of the

organization, lack of adequate program and cost data, and the difficulty of administering

programs that involve several organizational units. Yet despite its limitations, program

budgeting is often used as a planning device while budget allocations continue to be made in

terms of objects and organizational unitsa process that has been adopted in many schoolsthroughout the nation. As with performance budgeting, PPB information may be used to

supplement and support traditional budgets in order to increase their informational value.

Zero-BasedBudgeting

The basic tenet of zero-based budgeting (ZBB) is that program activities and services must be

justified annually during the budget development process. The budget is prepared by dividing

all of a government's operations into decision units at relatively low levels of the organization.

Individual decision units are then aggregated into decision packages on the basis of program

activities, program goals, organizational units, and so forth. Costs of goods or services are

attached to each decision package on the basis of the level of production or service to beprovided to produce defined outputs or outcomes. Decision units are then ranked by their

importance in reaching organizational goals and objectives. Therefore, when the proposed

budget is presented, it contains a series of budget decisions that are tied to the attainment of

the entity's goals and objectives.

The central thrust of ZBB is the elimination of outdated efforts and expenditures and the

concentration of resources where they are most effective. This is achieved through an annual

review of all program activities and expenditures, which results in improved information for


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allocation decisions. However, proper development requires a great deal of staff time,

planning, and paperwork.

Experience with the implementation of this approach indicates that a comprehensive review of

ZBB decision packages for some program activities may be necessary only periodically.

Additionally, a minimum level of service for certain programs may be legislated regardless of

the results of the review process. As a result, ZBB has had only modest application in schools,although the review of program activities makes ZBB particularly useful when overall spending

must be reduced.

Outcome-FocusedBudgeting

Consistent with the evaluation objective, government budgeting is becoming increasingly

outcome-focused. Fiscal austerity, coupled with intense competition for governmental

resources, has precipitated an effort to ensure more effective use of resources at all levels of

government. Outcome-focused budgeting is the practice of linking the allocation of resources

to the production of outcomes. The objective is to allocate government's resources to those

service providers or programs that use them most effectively.

Outcome-focused budgeting is closely linked to the planning process in governments. For a

government entity to focus on outcomes, goals and objectives must be identified and tied to

budget allocations for the achievement of those objectives. This premise argues that mission-

driven (synonymous with outcome-focused) governments are superior to those that are rule-

driven because they are more efficient, are more effective in producing desired results, are

more innovative, are more flexible, and have higher employee morale (Osborne and Gaebler

1993). In the context of increased governmental scrutiny of governmental costs, including

schools, this model may receive more emphasis in the future.

TOP DOWN BUDGETING

There are two major approaches to coming up with a budget for a business or for an individual

project: top-down budgeting and bottom-up budgeting. While bottom-up budgeting is themore traditional way to approach budgeting projects and companies, top-down budgeting

began to be more popular among businesses and the government during the 1990s. Top-down

budgeting is more often resorted to by companies and the government in times of fiscal stress.

Top-down budgeting has several advantages over bottom-up budgeting, along with several

disadvantages when compared to bottom-up budgeting.

As instead of building a budget from the bottom up, an overall estimate that is made of the

higher level tasks. Then those estimates of higher-level tasks are used to set limits on the costs

of lower-level tasks. Money funnels down from higher level tasks down to the lower level tasks

until all tasks that are necessary for a project are given funding. The budgeting process begins

with overall project managers. The estimate for a project or for a larger budget depends uponthe experience and the judgment of the manager or the managers who are in charge of coming

up with an overall budget.

Budget as a political instrument

It is economic as well as political toll. there is a various kind of issues,conflicting interest in

society which can be incorporated in budget.It is a tool of coordination. Government cuts the


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demanded exp by different ministers and during this many conflicting interest arises and if

budget succeed in coordination,it is definitely tool of coordination.

Budget depends on

1.Nature of State and Govt.-Expand taxation policy very much depends on nature of thestate,whether capitalist or communist.Pre 1991 one of the main aim of exp.was psu and

taxation was very which to diffuse the inequality.Whether the Govt. is leftist/rightist/neutral

budget also change accordingly.

2.Go fulfill the promises of the political parties when parties comes to power,they expected to

fulfill their promises .so budget in this nature ,it is constructive tool as for what a party has got

mandate,they are fulfilling negative side.

3.Lobbing small section of society can come together to put pressure on govt. to modify the

policy to achieve their object,may be at the cost of major part countrys population.

Eg:-Farm Lobbiys pressure to increase the price of food grain.

4.Populist policy Govt. in power to get their own political millege comes out with a policy

which may not have sound economic justification.Have the group is not necessary organized

but the political parties try increase their vote bank.eg.-subsidy on LPG,electricity,water etc.

5.High fiscal deficit with unstable govt.-As expenditure is higher as they know they are not

going to come in power again but their policy can be remain longer.

6.Nature of pre-election budget:-The kind of incentives and benefits offered are very populist in

nature in the last budget.

Thus it is not a hardcore economics takes place but aim is also to achieve political goal

THE BUDGETARY PROCESS

With the attainment of Independence, the objectives, the policy framework and the

environment of financial administration underwent a radical change. The conflict between

popular will and aspirations and the policy and procedures which had characterised financial

administration in the country disappeared overnight. Even though the basic features of the

Government of lndia Act, 1935, with regard to financial administration, were retained, there

was no fundamental disharmony between these instruments and the national priorities. These

instruments could be and were refashioned according to the changed objectives. The budgetary

processes in India follow the procedure laid down in Articles 112to 117 of the Constitution.

Accordingly, annual budget of the Union, called the Annual Financial Statement of estimated

receipts and expenditure, is to be laid before both Houses of the Parliament in respect of every

financial year. The Budget shows the receipts and payments of government under three parts inwhich government accounts are kept :

i) Consolidated Fund,

ii) Contingency Fund, and

iii) Public Account.


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Consolidated Fund of India

All revenues received by government, loans raised by it, and also its receipts from recoveries of

loans granted by it form the Consolidated Fund. All expenditure of government is incurred from

the Consolidated Fund and no amount 'can be withdrawn from the fund without authorisation

from the Parliament.

Contingency Fund

Occasions may arise when government may have to meet urgent unforeseen expenditure

pending authorisation from the Parliament. The Contingency Fund is an Imprest placed at the

disposal of the President to incur such expenditure. Parliamentary approval for such

expenditure and for withdrawal of an equivalent amount from the Consolidated Fund is

subsequently obtained and the amount spent from Contingency Fund is recouped to the Fund.

The corpus of the fund authorized by the Parliament, at present, is Rs. 50 crore.

PublicAccount

Besides the normal receipts and expenditure of government which relate to the Consolidated

Fund, certain other transactions enter government accounts, in respect of which government

acts more as a banker; for example, transactions relating to Provident Funds, small savings

collections, other deposits etc. The moneys thus received are kept in the Public Account and

the connected disbursements are also made therefrom. Generally speaking, Public Account

funds do not belong to government and have to be paid back some time or the other to the

persons and authorities who deposited them. Parliamentary authorisation for payments from

the Public Account is, therefore, not required.

Charged Expenditure

Under the Constitution, certain items of expenditure like emoluments of the President, salaries

and allowances of the Chairman and the Deputy Chairman of the Rajya Sabha and the Speaker

and Deputy Speaker of the Lok Sabha, salaries, allowances and pensions of Judges of the

Supreme Court and the Comptroller and Auditor-General of India, interest on and repayment of

loans raised by government and payments made to satisfy decrees of courts etc; are charged on

the Consolidated Fund. These are not subject to the vote of Parliament. The budget shows

thecharged expenditure separately in the Consolidated Fund. Government budget comprises :

i) Revenue budget; and

ii) Capital budget


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Revenue Budget

It consists of the revenue receipts of government (tax and non-tax revenues) and the

expenditure met from these revenues. The estimates of revenue receipts shown in the budget

take into account the effect of the taxation proposals made in the Finance Bill. Other receipts of

government mainly consist of interest and dividend on investments made by government, fees,

and other receipts for services rendered by government.

Capital Budget

It consists of capital receipts and payments. The main items of capital receipts are loans raised

by government from public which are called Market Loans, borrowings by government from

Reserve Bank and other parties through sale of Treasury bills, loans received from foreign

governments and bodies and recoveries of loans granted by Central Government to State and

Union Territory governments and other parties. Capital payments consist of capital expenditure

on acquisition of assets like land, buildings, machinery, equipment, as also investments in

shares etc. and loans and advances granted by Central government to State and Union Territory

governments, government companies, corporations and other parties. Capital budget also

incorporates transactions in the Public Account.

Demands forGrants

The estimates of expenditure from the Consolidated Fund included in the budget and required

to be voted by the Lok Sabha are submitted in the form of Demands for Grants. Generally, one

Demand for Grant is presented in respect of each ministry or department. However, in respect

of large ministries or departments, more than one demand is presented. Each demand normally

includes the total provisions required for a service, that is, provisions on account of revenue

expenditure, capital expenditure, grants to State and Union Territory governments and also

loans and advances relating to the service. Where the provision for a service is entirely for

expenditure charged on the Consolidated Fund, for example, interest payments, a separate

appropriation, as distinct from a demand. is presented for that expenditure and it is not

required to be voted by Parliament. Where. however, expenditure on a service includes both

'voted' and 'charged' items of expenditure, the latter are also included in the demand

presented for that service but the 'voted' and 'charged' provisions are shown separately in that

demand.Plan expenditure forms a sizeable proportion of the total expenditure of the central

government. The Demands for Grants of the various ministries show the plan expenditure

under each head separately from the non-plan expenditure. The document also gives the total

plan provisions for each of the ministries arranged under the various heads of development and

highlights the budget provisions for the more important plan programmes and schemes. A large

part of the plan expenditure incurred by the central government is through public sector


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enterprises. Budgetary support for financing outlays of these enterprises is provided by

government either through investment in share capital or through loans. The budget shows the

estimates of capital and loan disbursements to public sector enterprises in the current and the

budget years for plan and non-plan purposes and also the extra-budgetary resources available

for financing their plans, The Railways and Telecommunication services are the principaldepartmentally-run commercial undertakings of government. The budget of the Railways and

the demands for grants relating to Railway expenditure are presented to parliament separately.

However, the total receipts and expenditure of the Railways are incorporated in the Central

Budget. The demands for grants of the Department of Telecommunications are presented along

with other demands of the central government.

BUDGETARY CYCLE

In order to allow time for the executive and legislative processes to go through, budgeting is

geared to a cycle. The process of approval is very significant in a responsible form ofgovernment. The cycle consists of four phases:

Preparation and submission;

Approval;

Execution; and

Audit

At any given point of time, several cycles would be in operation and would beoverlapping.'Nevertheless, various segments of a cycle have different operational life.

Budget Preparation

In India, budget preparation formally begins on the receipt of a circular from the Ministry of

Finance sometime during September/October, that is, about six months before the budget

presentation. The circular prescribes the time-schedule for sending final estimates separately

for plan and non-plan, and the guidelines to be followed in

the examination of budget estimates to be prepared by the department concerned The general

rule is that the person who spends money should also prepare the budget estimates. Budget

proposals normally contain the following information:

i) Accounts classification

ii) Budget estimates of the current year


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iii) Revised estimates of the current year

iv) Actuals for the previous year; and

V) Proposed estimates for the next financial year (which is the budget proper).

Budget estimates normally involve :

a) Standing charges or committed expenditure on the existing level of service. Thiis

can easily be provided for in the budget, as it is more or less based on a projection of the

existing trends.

b) New expenditure which may be due to :i) expansion of programmes involving expenditure in

addition to an existing service or facility; and

i ) new service for which provision has not been previously included in the,, grants.

while we can be estimated with reference to progress made and the likely expenditure during

the next financial year, budget provision for (b) (i) and (ii) cannot be made unless the scheme

relating to it is finally approved.

The budget estimates prepared by the ministries/depanments according to budget and

accounts classification are scrutinised by the Financial Advisors concerned. The plan items of

the Central Budget are finalised in consultation with the Planning Commission and are based on

the Annual Plan. Parlinmentary Approval The estimates of expenditure prepared by

ministries/departments are transmitted to the Ministry of Finance by December where theseare scrutinised, modified where necessary and consolidated. The estimates of revenue are also

prepared by the Finance Ministry and thus the budget is finalised.

Budget Approval

The budget presented in Parliament generally on the last working day of February. In the first

stage, there is a general discussion on the broad economic and fiscal policies of the government

as reflected in the budget and the Finance Minister's speech. This lasts about 20-25hours.

In the second stage, there is a detailed discussion on the demands for grants, usually in

respect of specific ministries or departments. Each demand for grant is voted separately. At this

stage members of parliament may move motions of various kinds.

Generally these are policy cuts, economy cuts, and token cuts.


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The policy cut motion seeks to reduce the demand to rupee one and is indicative of the

disapproval of general or specific policy underlying the service to which the demand pertains.

The motion for economy cut is to reduce the proposed expenditure by a specified amount.

A token cut in a demand is moved to reduce it by a nominal amount say Rs. 100 and may be

used as an occasion to ventilate a specific grievance.

Since it is never possible to accommodate a detailed discussion on each demand for grant

separately, the demands that cannot be so discussed are clubbed together and put to the vote

of the Parliament at the end of the period allotted for discussion. Though the budget is

presented before both Houses of Parliament, the demands for grants are submitted only to the

lower house. Demands for grants, are the executive's requisitions for sanction to spend, and

only the lower house can have a say in the matter. While the legislature can object to a demand

for grant, reject it or reduce it, it cannot increase the same. It may also be mentioned here that

since no demand for a grant can be made except on the recommendations of the President orthe Governor (in the case of State), private members cannot propose any fresh items of

expenditure. If this were allowed it would necessitate revision of receipts and consequently the

budget and sometimes may lead to improper appropriation of public funds. Even after the

demands for grants have been voted by the Parliament, the executive cannot draw the money

and spend it. According to the Constitutional provisions, after the demands for grants are voted

by the Lok Sabha, Parliament's approval to the withdrawal from the Consolidated Fund of the

amount so voted and of the

amount required to meet the expenditure charged on the Consolidated Fund is sought through

the Appropriation Bill. The Appropriation Bill after it receives the assent of the President

becomes the Appropriation Act. Thus, without the enactment of an Appropriation Act, no

amount can be withdrawn from the Consolidated Fund.

Since the financial year of the government is from 1st April to 31st March, it follows that no

expenditure can be incurred by the government after 31st March unless the Appropriation Act

has heen passed by the close of the financial year. This is generally not possible as the process

of discussion of the budget usually goes on up to the end of April or the first week of May. Thus,

in order to enable the government to carry on its normal activities from 1st April till such time

as the Appropriation Bill is enacted, a Vote on Account is obtained from Parliament through anAppropriation (Vote on Account) Bill.

The proposals of government for levy of new taxes, modification of the existing tax structure or

continuance of the existing tax structure beyond the period approved by Parliament are

submitted to Parliament through the Finance Bill. The members can utilise the occasion of

discussion on the Finance Bill to criticise government policies, more specifically the proposals


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regarding the taxation and tax laws. In certain cases, taxation proposals take effect

immediately. Since, however, passing of the Finance Bill may entail a time lag, a mechanism

under which the taxation proposals take effect immediately pending the passing of the Finance

Bill exists in the form of Provisional Collection of Tax Act, 1931, which empowers the

government to collect taxes for a period of 75 days till the Finance Bill is passed and comes intoeffect.

The budget of the Central Government is not merely a statement of receipts and expenditure.

Since Independence, with the launching of five year plans, it has also become a significant

statement of government policy. The budget reflects and shapes, and is in turn shaped by, the

country's economic life. A background of the economic trends in the country during the current

year enables a better appreciation of the mobilkation of resources and their allocation as

reflected in the budget. A document, Economic Survey, is prepared by the government and

circulated to the members of Parliament a couple of days before the budget is presented. The

Survey analyses the trends in agricultural and industrial production, money supply, prices,

imports and exports and other relevant economic factors having a bearing on the budget.

Execution of the budget

The execution of the budget is the responsibility of the executive government. The procedures

for execution of the budget depend on the distribution and delegation of powers to the various

operating levels. As soon as the Appropriation Act is passed, the Ministry of Finance advises

spending Ministries/ Departments about their respective allocation of funds. The controlling

officers in each ministry/department then allocate and advise the various disbursing officers.

The expenditure is monitored to ensure that the amounts placed at the disposal of the

spending authorities are not exceeded without additional funds being obtained in time. Thus

the financial system broadly consists of the following levels :

a) controlling officers; normally the head of the ministry/department acts as the controlling

officer;

b) a system of competent authorities who issue financial sanction;

c) a system of drawing and disbursing officers; and

d) a system of payments, receipts and accounts.

The Department of Revenue in the Ministry of Finance is in overall control and supervision over

the machinery charged with the collection of direct and indirect taxes. Such control is exercised

through the Central Board of Direct Taxes and the Central Board of Indirect Taxes. These Boards

exercise supervision and control over the various operational levels which implement different


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taxation laws. The Reserve Bank of India is the central banker of the government. The

nationalised banks and the network of treasuries are also performing the service of collection

(receipts) and disbursement of funds.

Audit

The executive spends public funds as authorised by the legislature. In order to ensure

accountability of the executive to the legislature, public expenditure has to be audited by an

independent agency. The Constitution provides for the position of the Comptroller and Auditor

General of India to perform this function. It is his/ her duty to ensure that the funds allocated to

various agencies of the government have been made available in accordance with law; that the

expenditure incurred has the sanction of the competent authority; that rules, orders &

procedures governing such expenditure have been duly observed; that value for money spent

has been obtained and that records of all such transactions are maintained, compiled and

submitted tothe competent authority.

PROBLEMS & RECOMMENDATIONS IDENTIFIED by 2nd ARC

1. Unrealistic Budget Estimates

a. The assumptions made while formulating estimates must be realistic. At the end of each

year the reasons for the gap between the estimates and actuals must be ascertained and

efforts made to minimize them. These assumptions should also be subject to audit.

b. The method of formulation of the annual budget by getting details from different

organizations/units/agencies and fitting them into a predetermined aggregate amount leads to

unrealistic budget estimates. This method should be given up along with the method of

budgeting on the basis of analysis of trends. This should be replaced by a top-down methodby indicating aggregate limits to expenditure to each organization/agency.

c. Internal capacity for making realistic estimates needs to be developed.

2. Delay in Implementation of Projects

a. Projects and schemes should be included in the budget only after detailed consideration.

The norms for formulating the budget should be strictly adhered to in order to avoid making

token provisions and spreading resources thinly over a large number of projects/schemes.

3. Skewed Expenditure Pattern Rush of Expenditure towards the end of the Financial year

a. The Modified Cash Management System should be strictly adhered. This System should be

extended to all Demands for Grants as soon as possible.

4. Inadequate Adherance to the Multi-year Perspective and Missing Line of Sight betweenPlan and Budget

a. A high Powered Committee may be constituted to examine and recommend on the need

and ways for having medium-term expenditure limits for Ministries/Departments through the

Five year Plans and linking them to annual budgets with carry forward facility.

b. In order to bring about clarity, transparency and consolidation, the ways and means for

implementing an alignment project, similar to that in the UK, may also be examined by the

high Powered Committee so constituted.


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5. Adhoc Project Announcements

a. The practice of announcing projects and schemes on an ad-hoc basis in budgets and on

important National Days, and during visits of dignitaries functionaries to States needs to be

stopped. Projects/schemes which are considered absolutely essential may be considered in the

annual plans or at the time of mid-term appraisal.

6. Emphasis on Meeting Budgetary Financial Targets rather than on Outputs and Outcomesa. Outcome budgeting is a complex process and a number of steps are involved

before it can be attempted with any degree of usefulness. A beginning

may be made with proper preparation and training in case of the Flagship

Schemes and certain national priorities.

7. Irrational Plan Non Plan Distinction leads to Inefficiency in resource Utilization

a. The Plan versus non-Plan distinction needs to be done away with.

8. Flow of Funds relating to Centrally Sponsored Schemes

a. The Controller General of Accounts, in consultation with the C&AG, should lay down the

principles for implementing the system of flow of sanctions/ approvals from the Union

Ministries/Departments to implementing agencies in the States to facilitate release of fund at

the time of payment. After taking into account the available technology and infrastructure for

electronic flow of information and funds, especially under the NeGP,(national e-gov. plan) and

putting in place a new Chart of Accounts, the scheme should be implemented in a time bound

manner.

9. Development of Financial Information System,

a. A robust financial information system, on the lines of SIAFI of Brazil, needs to be created in

the government in a time bound manner. This system should also make accessible to the

public, real time data on government expenditure at all levels.

10. Capacity Building

a. The capacity of individuals and institutions in government needs to be improved in order to

implement reforms in financial management. To facilitate this, a proper programme of trainingneeds to be devised and implemented in a time bound manner.

11. Accrual System of Accounting

a. A Task Force should be set up to examine the costs and benefits of introducing the accrual

system of accounting. This Task Force should also examine its applicability in case of the

Appropriation Accounts and Finance Accounts.

b. Initially, a few departments/organizations may be identified where tangible benefits could

be shown to be derived within 2-3 years by implementing the accrual system of accounting,

especially departmental com

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