Wednesday, March 4, 2015

The Explainer: Why Fiscal Deficit is Dangerous

In the third part of the Understanding the Budget Series, I had explained Fiscal Deficit. This post will focus on the adverse consequences of Fiscal Deficit.

Before that, let me address a pertinent question: Where does the Government of India borrow from?

The three major sources of borrowing for the government of India are: (a) RBI, (b) foreign lenders (sovereign governments and international organisations like IMF and World Bank), and (c) from the general public of this country.

Contrary to popular perception, the government borrows most from the general public, through the issue of bonds (pretty much like fixed deposits).

(Read The Explainer: Budget Terminology - Part I and Part II)

What are the adverse consequences of Fiscal Deficit?
A high and rising Fiscal Deficit is bad for the general state of the economy, trade balance, and currency exchange rate.

Rising interest rates

A high Fiscal Deficit would mean the government’s borrowings are high. When the government borrows money from the general public, it creates demand for money. 

Lending to government carries zero risk, as the government will not default on repayment. However, greater government borrowing would mean less money would be available for lending to industrial and other sectors of the economy. This would push up interest rates for the borrowers from the industry.

Reduced business & economic activity

Higher interest rates would add to overall cost of production, thereby increasing cost of operations. This in turn would render business activity, like increased production and expanding operations, unviable. Hence, a lot of businesspersons would then opt out of such economic activity as they no longer find it profitable.

Reduced income & employment generation

If due to higher interest rates businesspersons opt out of economic activity or close down plants, it would also reduce employment generation. This would in turn mean that the retrenched (those thrown out of jobs) and the unemployed do not earn income, thus reducing their purchasing power.

If purchasing power goes down, then their aggregate demand for goods and services would also go down. This in turn would also reduce industrial activity, thereby depressing overall economic scenario.

Lowers exchange rate & rises trade deficit

Sometimes the government of India would borrow from foreign sources. When the government is lent money, foreign exchange comes into the economy. This would increase the supply of the foreign currency, which in turn would be exchanged for the Indian rupee.

The rise in demand for the Indian currency would increase its value. Simply put, as foreign entities begin to exchange their currency for Indian rupee, the value of the Indian rupee will also increase.

For example, the exchange value of the Indian rupee for each U.S. dollar is Rs61. In this scenario, let’s say, when a foreign entity is exchanging its currency for Indian rupee in large volumes, the exchange value may fall to Rs59 per U.S. dollar.

This means that while earlier one U.S. dollar would have fetched Rs61, now it would fetch only Rs59. This would hurt exports and encourage imports. How?

As an an importer, in the past you were paying Rs61 per U.S dollar of import while now you are paying only Rs59. This means that your cost of operations would also go down.

However, if you are an exporter, then this would mean that you would earn less from your exports; like earlier you were earning Rs61 for U.S. dollar of export while now it is only Rs59!

If exports go down and imports go up, then the trade deficit will also widen, which in turn increases the Current Account Deficit. 

Also, high borrowings now would mean that the country's financial position becomes precarious as it piles higher debt and interest burden on future generations

In short, a high Fiscal Deficit is dangerous in every way possible: for general economic activity, employment generation, exchange rate, and trade balance.

Monday, March 2, 2015

The Explainer: Understanding Fiscal Deficit

Continuing with the Explainers in the 'Understanding the Budget Series', this post will dwell on the idea of Fiscal Deficit, a crucial factor in ensuring a stable economic environment. 

(Read The Explainer: Budget Terminology - Part I and Part II)

What is Fiscal Deficit?
Fiscal Deficit is defined as the difference between the government's total expenditure and the total non-debt creating receipts.

What types of receipts are non-debt creating?
Revenue Receipts, Recoveries of Loans, and Other Receipts are all non-debt creating. This means that the government does not have to borrow to generate these sources of income.

Now, look at the accompanying table: Fiscal Deficit is numbered 22, Revenue Receipts is 1, Recoveries of Loans is 5 and Other Receipts is numbered 6.

(22) Fiscal Deficit = (16) Total Expenditure – [(1) Revenue receipts + (5) Recoveries of loans + (6) Other Receipts]

Revenue Receipts
 would include both tax and non-tax revenue of the Government of India (GoI).

What is tax revenue?
This refers to revenue that the GoI gets by way of collecting taxes, like Personal Income Tax, Corporate Tax (charged on incomes of companies), Central Sales Tax and Service Tax.

What is Non-tax revenue? 
This would include Stamp Duty and Dividends earned from Public Sector Units (PSUs). Dividend is the return on capital invested by the government in PSUs.

Sometimes the government of India receives money that it would have lent to some country/organisation in the past. When such money is received, it is recorded under the ‘Recoveries of Loans’ head.

When does Fiscal Deficit arise?
Fiscal Deficit arises when the government has expenditure higher than the revenue it generates. To bridge this expenditure-revenue deficit, the government resorts to borrowing. This borrowing is called Fiscal Deficit.

In short, fiscal Deficit is the total borrowing of the government of India to fund the allocations and expenditures listed in the Union Budget.

In the table above, the Revised Estimates for 2014-15 show a Fiscal Deficit of Rs5,12,628 crore. In other words, what this figure means is that the Government of India is borrowing this huge amount of money in 2014-15! Yes, you got it right: a total borrowing of mind-numbing Rs5.12 lakh crore in one year!

Fiscal Deficit is usually expressed in terms of percentage of the country’s Gross Domestic Product (GDP).

Now, go to the bottom of the table. It is mentioned that India’s GDP in 2014-15 will be Rs12653762 crore; yes, you read it right: Rs126 lakh crore!

Taking India’s GDP to be Rs12653762 crore in 2014-15, the Fiscal Deficit of Rs5.12 lakh crore works out to 4.1% of GDP.

So, to say that we are living way beyond our means would be an understatement. While the government has done well to stick to the targeted Fiscal Deficit (see Budget Estimates and Revised Estimates for 2014-15), one that is high could spell doom for the economic growth of the country.

The next post will focus on the adverse consequences of Fiscal Deficit.

Sunday, March 1, 2015

The Explainer: Budget Terminology - Part II

, I wrote the first p
art in the 'Understanding the Budget' Series under The Explainer Series.

(Read: The Explainer: Budget Terminology - Part I)

In today's article, I am going to address some very important aspects of the Union Budget.

What does the Budget consist of?

Take a look at the table graphic below. This document titled, Budget at a Glance, is the best document to understand the components of the various types of figures in the Budget. 

The Union Budget 2015-16 consists of the following:
(a)   Actuals for 2013-14
(b)   Budget Estimates for 2014-15
(c)   Revised Estimates for 2014-15
(d)   Budget Estimates for 2015-16

The Actuals for 2013-14 may be represented as such but they STILL would be PROVISIONAL only (see notes below the table in the above graphic). This means that these figures are NOT the final figures for 2013-14 but are subject to further revision. In fact, the final figures for 2013-14 will only be available toward the end of Financial Year 2015-16 (or Fiscal Year ’16).

Budget Estimates (BE) relate to the figures which the Finance Minister set out in his Budget Speech last year (i.e., on 28 February 2014) for the Financial Year 2014-15.

However, all figures – related to revenue collection, expenditure, other allocations – are subject to change. These numbers are mere ESTIMATES and not actuals. As the year progresses, such figures may sometimes need to be revised. For example, if there is low industrial and agricultural activity (meaning lower economic output), tax collections may dip. This, in turn, will reduce the government’s Revenue Receipts.

In such case, the Government may revise the Budget Estimates (made in the Budget). Such altered figures are labeled Revised Estimates (RE). These RE are listed in the third column.

In the fourth and last column, you will find Budget Estimates for the coming Financial Year 2015-16. These figures reflect the various estimates made by the Government in terms of Receipts (including tax collections) and Expenditures (including interest payments and salary payments to government employees).

What are the different types of accounts listed in the Budget?
There are three types of accounts listed in the Budget. They are:
(a)   Consolidated Fund of India;
(b)   Contingency Fund of India, and
(c)   Public Accounts.

What is the Consolidated Fund of India?
This is the most important account maintained by the Government of India. The Consolidated Fund of India contains all the revenues (tax and non-tax revenues) earned and all the expenditures incurred by the Government of India.

No money from the Consolidated Fund of India can be spent by the Government without approval of the Parliament of India.

What is the Contingency Fund of India?
Contingency means ‘unforeseen’ or ‘emergency’. As mentioned above, all withdrawals  from the Consolidated Fund of India require prior approval of the Parliament. 

However, sometimes there are emergency expenses for which the Government may not wait for the Parliament’s approval; like, expenses incurred to tackle a devastating flood/earthquake.

In such cases, the Government of India will withdraw funds from the Contingency Fund of India. Once the expense is met, the Government may seek approval of the Parliament for such withdrawal. In short, the Parliament’s approval comes post-facto (i.e., after the expense has been made).

However, after the Parliament approves such expense, an equal amount is withdrawn from the Consolidated Fund of India to be put back into the Contingency Fund of India.

What are Public Accounts?
Public Accounts hold money that does not belong to the Government of India. Such accounts include the Employees Provident Fund and Small Savings Scheme. This money belongs to the general public but is held in Government’s trust.

Whenever withdrawals are made from such accounts, the Government pays out the amounts without the Parliament’s approval.

I hope this was easy to understand. Please share your feedback.

Saturday, February 28, 2015

The Explainer: Budget Terminology - Part I

In India, there is hardly any economic event that captures popular imagination as much as the Union Budget. In this Budget series, The Explainer will focus on the complex budget jargon that puts off even interested-in-budget souls.

So, here we go!

What is a Fiscal Year?
Any twelve-month period that is used for submission of accounts, taxation purposes and to state financial reporting by private and public sector companies is called a Fiscal Year.

In India, the Government has laid down the provision that the 12-month starting on April 1 and ending on March 31 of next year will be treated as a Fiscal Year.

To put it in perspective, this article is being written on 28 February 2015, i.e., in Financial Year 2014-15. This is also called Fiscal Year ’15.

In the same way, the financial year for 2015-16 will start on 1 April 2015 and will end on 31 March 2016. So on 1 April 2015, we will enter Fiscal Year ’16.

Why is the Union Budget presented on the last day of February?
The Finance Minister of India presents the annual Union Budget in the Parliament of India. It is typically presented on the last day of February, for the following reasons: 

(a) After presentation, the Budget is tabled in the Parliament where members of both the Houses would debate the various provisions listed in the Budget. This would require a few days of debate and discussion. 

(b) Also, after such budget debate, any amendment to the original provision (like increasing or decreasing the allocation for a said ministry/program and rolling back any budget proposal) will have to be tabled, discussed, passed, and brought into law by the Parliament. 

(c) Also, the administrative system, especially in case of tax administration, would need to be geared up to reflect any change in the financial, taxation or any other system.

What is the Economic Survey?
The Finance Minister's Budget Speech contains two major components: Part A and Part B.

Part A of the Speech contains the Economic Survey while Part B comprises the Union Budget Speech.

The Economic Survey is tabled by the Ministry of Finance in the Parliament along with the Union Budget.

The Economic Survey is an assessment of the performance of the Indian economy in the fiscal year going by. For example, the Economic Survey 2014-15 presents an assessment of the performance of the Indian economy in that fiscal year (i.e., 2014-15).

What is the Budget?
So while the Economic Survey is an assessment of the performance of the Indian economy in the fiscal year gone by (i.e., the one that ends on March 31 this year), the Union Budget is a statement of revenues and expenditures for the coming fiscal year, i.e., the one that starts on April 1 of this year.

The second part of this Explainer will appear tomorrow.