Introduction

Ever since Dr.Manmohan Singh announced his policy of opening up the Indian Economy in the 1991-92 budgets, the annual budget of the central government has ceased to be the mere statement of government accounts. It is widely accepted as the definitive statement of the central government policies both in the fiscal domain and in the range of other areas. As with most of the government documents, the budget papers have their fair share of jargon that often obfuscates some of the most critical issues being addressed. This project report tries to demystify this issue and identify some of the key issues at the heart of the budget. Here we discuss: The definition and implication of some of the important budget parameters linking the financial market Fiscal policy (one of the Budgetary policies) Objectives of fiscal policies Some of the key fiscal trends that have emerged as a critical area of concern and the direction going forward. Analysis of the Public Expenditures since 1990s Trends in deficit since 1990s

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The budget the basic concepts

The union budget provides a summary of the receipts and expenditures of the central government for the previous fiscal year and the estimates for the following year .the previous years summary is referred to as the estimates and the following years forecasts are referred to as budget estimates .budgeting is done for the fiscal year, the twelve month period spanning April of a particular year to March next year.

A simple classification
Both receipts and expenditures are classified into revenue and capital.

Revenue receipts comprises of taxes, interest on loans, dividends paid by central

government owned public sector companies.(here interest on loans, dividends paid by central government owned public sector companies are part of non tax revenues) Capital receipts consists of loans repaid to the central government, money collected from sale of government stake in the public sector or similar items.

Revenue expenditure is expenses incurred on the day to day running of government,

servicing the government borrowings and paying subsidies. It forms about 50% of the total expenditure. Capital expenditure is expenses incurred on creating physical assets. (Total expenditure = revenue expenditure + capital expenditure)

Total expenditure(%)
25% 50% 9%

Others Defence Subsidies

16%

Interest

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Revenue deficit is the difference between the total expenditure and total receipts Plan expenditure is an expenditure that the government plans to incur on a scheme to be
implemented in a given year. For example, in the year 2003-04 (as per the revised estimates for that year), the government had allocated Rs 2588.62 crores (Rs 25.886 billion) for construction of national highways. This expenditure that was incurred for construction of national highways came in as a part of plan expenditure.

Non-plan expenditure is defined as expenditure committed by the expenditure. Interest

payments, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure. Basically,

Capital Expenditure + Revenue Expenditure = planned expenditure + Non planned expenditure Fiscal Deficit is the difference between the total expenditure and total revenue of the
economy.

Fiscal Responsibility and Budget Management Act (FRBMA).

The FRBMA was notified on July 2, 2004 and came into force on July 5, 2004. This Act requires the reduction of fiscal deficit and elimination of revenue deficit by March 31, 2009. The FRBMA requires the Government of India to reduce fiscal deficit by a minimum of 0.3 per cent of the GDP every year and revenue deficit by 0.5 per cent each year, so that the fiscal deficit is not more than 3 per cent of the GDP by March 31, 2009. The idea seems to be that deficit, if any, should be used to finance capital expenditure that leads to asset formation and not on revenue expenditure, the benefits of which do not go beyond that particular year. The FRBMA has certain loopholes. It does not require capital expenditure leading to a deficit to recoup its cost of capital (i.e., the return generated on the investment done through capital expenditure need not be greater than the interest to be paid on it). This might lead to the overall spending and deficits to be quite unconstrained.

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Public expenditure
Public expenditure refers to Government expenditure. It is incurred by Central and State Governments. The public expenditure is incurred on various activities for the welfare of the people and also for the economic development, especially in developing countries. The various areas of public expenditure are: Economic Infrastructure which includes: Power Transport Irrigation etc. Social Infrastructure which consists of: Health Education Family welfare Non development activities such as: Administration Interest payments Subsidies

The Government expenditure can be broadly classified as follows: Capital and Revenue Expenditure Productive and Unproductive Expenditure Transfer and non-transfer Expenditure

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CAPITAL EXPENDITURE Capital Expenditure of the government refers to that expenditure which results in creation of fixed assets. Certain areas of infrastructure activities have to be undertaken by the Government. The private sector may not be interested in certain capital expenditure due to the huge sums involved or due to long gestation period. For instance, power generation, construction of roadways, dams, etc., requires huge sums of money, which the private sector may not be able to invest, especially in developing countries. Also, if certain areas are allowed to be developed by private sector, they may exploit the users or the public who -use such infrastructure. Therefore, the government has to incur expenditure on build up fixed assets or infrastructure for the social and economic development. In developed countries, private sector plays a significant role in the development of infrastructure due to large funds available at its disposable. However, in developing countries, the Government has to play a lead role in the development of infrastructure for the growth of the economy. Although, the return on such investments may be very low for the Government due to social pricing, but the social advantage is enormous. Capital expenditure is productive in nature: The capital expenditure of the government is incurred on infrastructure development activities such as: Energy or power generation. Transport Irrigation and agriculture development. Social infrastructure development such as construction of schools, hospitals, etc.

The power generation, development of transport, agricultural development and social development facilitate growth of the various sectors of the economy. Therefore, capital expenditure is productive in nature, i.e., such expenditure directly contributes to the economic and social development of a nation.

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Capital expenditure need not always be productive: Certain types of capital expenditure of the government need not be productive at all. For instance, capital expenditure incurred on housing for government employees and for installation of expensive gadgets in government offices such as air conditioners may not be directly productive; as such expenditure may not directly contribute to the economic growth of the nation. The unproductive or non-developmental capital expenditure suffers from two limitations: It does not bring any return on investment.

It puts interest burden on the government, as the government has to finance such expenditure through borrowings. Certain capital expenditure may generate only social development: Certain types of capital expenditure such as capital expenditure on health, education and family welfare, defense equipments, etc., may only generate social development such as increase in literacy and life expectancy, control of population, improvement in social order, etc. Such expenditure does not directly result in economic development. However, no society can economically prosper, if it is socially backward. There is no doubt that social development facilitates economic development, as is being seen in developed countries. Therefore, the governments of developing countries should place lot of emphasis on social development expenditure, and allow the private sector to participate in economic infrastructure development. Capital expenditure may be remunerative as well as non-remunerative: The capital expenditure may be remunerative. For instance, the government can get good returns on investment in the areas of oil and gas exploration, power generation, extraction of minerals, etc. The government also can get return through taxation. For instance, the capital expenditure can result in higher growth of output, which in turn would increase the national income or the tax base, and therefore, the government can get higher revenue in form of taxation. However, certain government expenditure may not bring direct remunerative returns, such as expenditure on health and education REVENUE EXPENDITURE The revenue expenditure of the government refers to the consumption expenditure such as payment of wages/salaries, expenditure on public goods and services.

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Developed and developing countries have to spend a good amount as revenue expenditure. The revenue expenditure includes expenditure on: Maintenance of law and order. Defense activities. Maintenance of educational and health services, etc. The revenue expenditure can be broadly divided into two groups; Development Expenditure Non Development Expenditure Development Expenditure In modern times, the Governments spend a good amount of money on a number of social and community services. For instance: Development revenue expenditure on public education - relating to maintenance of educational institutions, staff salaries, etc. Development revenue expenditure on public health - such as maintenance of government hospitals, and health centers. Expenditure on family welfare activities, etc. The development revenue expenditure directly or indirectly results in human development, which in turn has an impact on the economic development of the nation. The rising development expenditure in a country may not necessarily result in development of the economy. For instance: A large amount of revenue funds may be spent on over-staffed government departments. Low level of efficiency in government organizations. Grant of unwarranted subsidies, which are often cornered by the section of the society, who don't deserve it. Misappropriation of revenue funds sanctioned for developmental activities such as employment generation projects and rural development projects.

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 A good amount of revenue funds is spent on unwanted activities such as meaningless surveys. Non-development Expenditure The non-development expenditure may not contribute directly to the economic and social development of the nation. However, certain activities must be undertaken so as to create a healthy environment for economic and social development. The revenue non-development expenditure includes: Maintenance of defense equipments, and salaries to defense personnel. Maintenance of government buildings and machinery. Salaries to the administrative staff. Tax collection expenses. Audit expenses incurred to check misappropriation of funds in government organizations. Interest payments. Expenditure on judiciary and police departments. Nowadays, a major share of non-development expenditure is due to interest payments. The Government borrows a large amount of funds for various activities. Therefore, the interest burden on the government increases due to interest payment account for about 1/ 3rd of the total Central Government revenue expenditure in India. Over the years, the interest payment of the central government has increased considerably. For instance, the interest payment of the central government was Rs.21, 500 crores in 1990-91, and it has increased to Rs. 1, 39,823 crores in 2006-07. Therefore, there is a need to cut down borrowings, or to repay the debts as early as possible in order to reduce interest burden of the government.

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Fiscal policy
Fiscal policy, taking the scope of budgetary policy, refers to government policy that attempts to influence the direction of the economy through changes in government taxes, or through some spending (fiscal allowances). Fiscal policy can be contrasted with the other main type of macroeconomic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the supply of money. The two main instruments of fiscal policy are government spending and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:

Aggregate demand and the level of economic activity The pattern of resource allocation The distribution of income.

Fiscal policy therefore refers to the overall effect of the budget outcome on economic activity. The three possible stances of fiscal policy are neutral, expansionary and contractionary:

A neutral stance of fiscal policy implies a balanced budget where G = T (Government spending = Tax revenue). Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. An expansionary stance of fiscal policy involves a net increase in government spending (G > T) through a rise in government spending or a fall in taxation revenue or a combination of the two. This will lead to a larger budget deficit or a smaller budget surplus than the government previously had, or a deficit if the government previously had a balanced budget. Expansionary fiscal policy is usually associated with a budget deficit. A Contractionary stance fiscal policy (G < T) occurs when net government spending is reduced either through higher taxation revenue or reduced government spending or a combination of the two. This would lead to a lower budget deficit or a larger surplus than the government previously had, or a surplus if the government previously had a balanced budget. Contractionary fiscal policy is usually associated with a surplus.

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Among the various tools of fiscal policy, the following are the most important: Reflationary Fiscal Policy: It may be used to boost the level of economic activity during periods of recession or deceleration in economic activity. This is done by lowering taxes or increasing government expenditure. Deflationary Fiscal Policy: During a boom, i.e., when the economy is growing beyond its capacity, inflation and balance of payment problems might result. This can be achieved by increasing taxes or by reducing government expenditure.

Significance to business economy in developing countries

The main goal of the fiscal policy in developing countries is the promotion of the highest possible rate of capital formation. Underdeveloped economies are in the constant deficit of the capital in the economy and thus, in order to have balanced growth accelerated rate of capital formation is required. For this purpose the fiscal policy has to be designed in a way to raise the level of aggregate savings and to reduce the actual and potential consumption of people. To divert existing resources from unproductive to productive and socially more desirable uses. Hence, fiscal policy must be blended with planning for development. To create an equitable distribution of income and wealth in the society. To protect the economy from the ills of inflation and unhealthy competition from foreign countries. To maintain relative price stability through fiscal measures. The approach to fiscal policy must be aggregate as well as segmental. The sectoral imbalances can be curbed by appropriate segmental fiscal measures. The government expenditure on developmental planning projects must be increased. For this deficit financing can be used. It refers to creation of additional money supply either by creation of new money by printing by government or by borrowing from the central bank. Public borrowing, loans from foreign nations etc can be used in the development of the resources for public sector. Fiscal policy in the developing economy has to operate within the framework of social, cultural and political conditions which inhibit formation and implementation of good economic policies.

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 In order to reduce inequalities of wealth and distribution, taxation must be progressive and government spending must be welfare-oriented. The hindrances in the effective implementation of fiscal policy in the developing countries are loopholes in taxation laws, corrupt tax administration, a high population growth, extravagant governmental spending on non-developmental items, an orthodox society etc.

The Limitations of Fiscal Policy

Fiscal policy has been a great success in developed countries but only partially so in developing countries. The tax structure in the developing countries is rigid and narrow. Thus, conditions conducive to the growth of well-knit and integrated tax policies are absent and sorely missed. Following are some of the reasons that are hindrances for its implementation in developing countries: 1. A sizeable portion of most developing economies is non-monetized, rendering fiscal measures of the government ineffective and self-defeating. 2. Lack of statistical information as regards the income, expenditure, savings, investment, employment etc. makes it difficult for the public authorities to formulate a rational and effective fiscal policy. 3. Fiscal policy cannot succeed unless people understand its implications and cooperate with the government in its implication. This is due to the fact that, in developing countries, majorities of the people are illiterate. 4. Large-scale tax evasion, by people who are not conscious of their roles in development, has an impact on fiscal policy. 5. Fiscal policy requires efficient administrative machinery to be successful. Most developing economies have corrupt and inefficient administrations that fail to implement the requisite measures vis--vis the implementation of fiscal policy. It would perhaps be too simplistic to conclude that fiscal policy is the most important tool of financial correction and consolidation, especially that undertaken by the government. However, there is no reason to neglect this very powerful tool that is in the hands of governments and central banks the world over. Used properly, fiscal policy can determine the broad direction the economy of a given country is going to take.

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Budgetary trends in India

India achieved self-sufficiency in food grains by the late 80s. Ever since, the focus of the government has been of capital goods. A major chunk of the expenditure, in the form of imports, was associated with capital goods. With time and better technology, Indian production and exports of consumer durables and goods, in general, started increasing. This however, was no match for the tremendous increase in demand, which in turn could be attributed to the rise in purchasing power of the masses and an improvement in the standard of living. Off late, the governments focus, as in any emerging market like India, has been on Infrastructure. The sector has been thrown open to private investors and investment in the form of Public-Private Partnerships (PPPs) is also encouraged. But detailed analysis of the subsequent budgets in India reveals some startling trends. Indias subsidy bill has been rising incessantly over the past decade and a half. In addition to the budgetary expenditure, India has various items termed as off-budget expenditure. Both these show no signs of slowing down. In a developing country like India, certain subsidies are unavoidable. Food subsidies, in the form of Public Distribution Systems, are indispensible. Fertilizer subsidies are extended to give a fillip to agricultural production. Crude prices have been soaring sky-high from the early 90s. From a meager $20 a barrel, crude had touched $146 a barrel. In this kind of a scenario, fuel subsidies are as necessary as fuel itself. Assuming the price of crude oil at $120 (Rs5, 076) a barrel, Morgan Stanley economist Chetan Ahya estimates the total budgetary gap to be 10.4% of the gross domestic product in the year ending 31 March 2009, up from just 7.7% last fiscal. If instead of $120, the average price of oil is assumed to be, say, $135 a barrel, the deficit estimate would rise to 11.4%, Ahya wrote in a 17 July note to investors. Ahyas calculation combines Central and state-level data with the so-called off-budget spending items. Apart from the subsidies on energy, food and fertilizers, off-budget items include the cost of the farm debt waiver programme as well as the expenditure to be incurred on a pay hike for civil servants. The last time the overall deficit exceeded 11% in India was in the year ended 31 March 2002. Back then, the economy was growing at an annual pace of just about 5.8%, against the central banks forecast of at least 8% expansion for the current fiscal year. The inflation rate was less than 2%, compared with about 12% now. In an effort to curb the ever-rising inflation, the government bore most of the oil price hike. This fits in as an increased subsidy, and hits the consumer a lot less. But, it also contributes to an increase in deficit.

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Public Expenditure
Introduction
The role of public expenditure in the fiscal policy goals of growth, equity and stability, has varied across different phases of economic development in India. The historical importance of public expenditure lies in the mixed economy model adopted after Independence in India whereby the government assumed the primary responsibility of building the capital and infrastructure base to promote economic growth. The concerns regarding equity and poverty alleviation after two decades of Independence added another important dimension to public expenditure in terms of redistribution of resources. The inadequate returns on capital outlays and the macroeconomic crisis of early Nineties arising out of high fiscal deficit shifted the focus of public expenditure to efficiency in its management for facilitating adequate returns and restoring macroeconomic stability. While the fiscal policy goal of stability could be achieved, the modus operandi of public expenditure management through curtailing capital expenditure raised concerns about infrastructure investment and its impact on the long-term growth potential of the economy. Furthermore, stagnating revenue mobilization in particular and some upward movements in expenditures led to a reversal of the fiscal stabilization process since the second half of the Nineties. An improved fiscal performance during 2003-04 engendered by containment of the non-plan expenditures and supported by high revenue mobilization on the back of buoyant real activity paved the way for renewed commitment towards fiscal consolidation in India.

Trends in public expenditure

Over the years, the expenditure of the Central Government and the State Governments has increased considerably. The growth of public expenditure and government expenditure is due to the following reasons:

Public Expenditure
Public sector investment and consumption expenditure have constituted important constituents of effective demand in the Indian economy. The investment process was initiated in the planning period with the public sector being in charge of the commanding-height of the industrial sector, representing infrastructure, heavy industries and defense that required heavy doses of capital formation. Accordingly, public sector investment rate improved from the low level of 2.8 per cent of GDP in 1950-51 to 11.7 per cent in 1986-87(Figure 1) The spurt in public investment during the late Seventies reflected governments response to the second oil shock by expansionary adjustment through increased investment and reorienting investment for boosting oil production and removing infrastructural constraints. However, in the wake of two successive monsoon failures in 1986 and 1987, the government had to resort to expenditure cuts that affected capital formation. Since the mid-Eighties, the public sector capital formation slackened which, however, did not narrow the saving-investment gap of the
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public sector as the public sector saving deteriorated more rapidly than investment. The assetwise distribution of public sector capital formation shows the predominance of investment in construction rather than machinery and equipment reflecting its greater accent on infrastructure (Table 1). A noteworthy feature has been a decline in the share of construction in the gross fixed capital formation in the public sector with a corresponding increase in that of machinery and equipment up to the Nineties which has somewhat reversed thereafter reflecting renewed emphasis on infrastructure.

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Public sector consumption has generally shown an upward trend up to the mid-Eighties reflecting expansion of the overall government sector. Since the mid-Eighties public sector consumption have shown sporadic episodes of expansion partly due to the revisions in wages and salaries of government employees. The rise in public consumption and decline in public investment have raised some concerns regarding the sustainability of the growth process particularly in the second half of The Nineties. Such an outcome in respect of public sector outlays was reflective of the shift in governments strategy for the development and growth process whereby the role of government was rationalized so as to allow a greater role for market forces. The increasing borrowings and monetization of the government deficits, however, had serious implications on the overall investment and growth of the economy as manifested by the macroeconomic crisis of the early Nineties. This called for fiscal consolidation leading to a series of measures in respect of expenditure as well as revenue of the government. It may be noted that the revenue enhancement was constrained by the need to align the tax rates with international standards and the fiscal correction mainly came from the expenditure side.

Government Expenditure

Population Growth: During the past 50 years of planning, the population of India has increased by 2.8 times. From 36.1 crores in 1950-51, it has reached at about 103 crores in 2001. The growth in population requires massive investment in health and education, law and social order, etc. Therefore, the government expenditure has increased during the planning period. Year population
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1950-51 2000-01

36.1 crores 103 crores

inc

Defense Expenditure: Over the years, the defense expenditure of the central government has increased. The defense expenditure is vital for maintaining national security. The defense expenditure minimizes the possibility of external threats, which in turn creates a good environment for social and economic activities of the nation. The increase in defense expenditure of the central government is stated as follows: Defense Expenditure - Central Government Year 1990-91 2006-07 Rs. Crores 10,874 51,542 %of GDP 1.9 1.3

Source: Economic Survey 2006-07 From the above table, it is clear that the overall government expenditure has increased, but as a percentage of GDP, it has declined. This means the central government has reduced expenditure in GDP terms.
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Increase in National Income: The national income of the country has increased over the years. The increase in national income resulted in more revenue to the government by way of tax revenue and other income, which in turn enabled the government to increase its expenditure. Government Subsidies: The Government of India has been providing subsidies on a number of items such as food, fertilizers, interest to priority sector, exports, education, etc. Because of the massive amounts of subsidies, the government expenditure has increased over the years. However, of late, the government has started to reduce subsidies on certain items in order to reduce government expenditure. The increase in central government subsidies is shown in the following table: Subsidies - Central Government Year 1990-91 2006-07 Rs'.Crore 9,581 44,792 % of GDP 1,7 1.1

Source: Economic Survey 2006-07 Although the overall expenditure has increased on subsidies, but as a percentage of GDP it has declined. This means, the central government is making efforts to reduce subsidies wherever possible.

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Interest Payment: The government borrowings are an increase. The government borrows funds from domestic market and from foreign sources to meet expenditure on various government activities. As a result, the government has to incur huge interest payments. The following table indicates increase in interest payments of the central government: Central Government - Interest Payments Year 1990-91 2006_07 Rs. Crores 21,500 139,823 % of GDP 3.8 3.4

Source: Economic Survey 2006-07

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develop

Administrative Machinery: There has been an increase in the administrative machinery in the country with the rapid growth of population and also economic development. Heavy expenditure is to be incurred on administrative machinery in respect of police, tax administration, administration of public sector enterprises, etc.

Development Projects: The government has been undertaking various development projects such as irrigation, iron and steel, heavy machinery, power, telecommunications, etc. The development projects require lot of capital and revenue expenditure. Urbanization: There has been an increase in urbanization. In 1950-51, about 17% of the population was urban based. Now the urban population has increased to about 28%. The increase in urbanization requires heavy expenditure on law and order, education, civil amenities like drinking water, housing, electricity, etc. Inflation:

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India has witnessed inflation in the past several years. Inflation results in increase in costs and expenses of various government activities. For instance, the costs and expenses relating to development projects rise due to inflation. Also, the government has to hike salaries of staff of various government departments on account of inflation. The procurement prices of essential requirements in government departments also rise due to inflation. Therefore, inflation is one of the major causes of increase in government expenditure. Social Development Activities: Modern governments have adopted the concept of welfare state. Therefore, increasing sums of money are being spent on social development activities such as: Health Education Family Welfare, etc. Poverty Alleviation Programmes: In developing countries, governments are spending a good amount of funds on poverty alleviation and employment generation programmes. For instance, the Government of India has introduced a number of poverty alleviation and employment generation programmes such as: Swarnajaynti Gram Swarojgar Yojana. Sampoorna Grameen Rozgar Yojana. National Food for Work Programme Prime Minister's Rozgar Yojana Indira Awaas Yojana, etc.

Research and Development: The government is spending a good amount of money on R&D. R&D is vital to improve quality and to reduce costs. The Government finances the R&D projects undertaken by nongovernment organizations, universities and other educational organizations. Wages and Pension The government is spending a good amount of money in wages and pension. They just provide financial assistance to the retired and the workers.

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EFFECTS OF PUBLIC EXPENDITURE If public expenditure is properly allocated and efficiently utilized, it can have an all round beneficial effect on the economy. Public expenditure can determine the level of income and its distribution. It can be used as a tool to manage aggregate demand, and thereby, to bring about stability in the economy. It can be used to improve income distribution and resource allocation. In developing countries, public expenditure policy is used to achieve economic growth, promote employment opportunities, to reduce poverty and inequalities in income distribution.

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The various effects of public expenditure can be analyzed as follows: Effects on Production: The effects of public expenditure on production can be examined with reference to its effects on ability and willingness to work, save and invest and on diversion of resources. Ability to work, save and invest: Socially desirable public expenditure increases community's productive capacity. Expenditure on education, health, communication, increases people's productivity at work and therefore their incomes. With rise in income, savings also increase and this in turn has a beneficial effect on investment and capital formation. Willingness to work, save and invest: The effect of community's willingness to work, save and invest depends upon the type of public expenditure. If public expenditure is incurred on social security measures like old age pension, unemployment allowance, social insurance, then people will expect the government to provide these benefits to them at the time of their need. Such expectations may have an adverse effect on willingness to work and save. They will not be motivated to work harder, earn higher income and save because they will expect government support. As savings get adversely affected, so will investments. In many developing countries, huge public expenditure on unproductive purposes results in inflation leading to decline in the value of money. During inflation people have a tendency to transfer their liquid assets to unproductive assets like real estate and gold. This may further strengthen inflation and reduce people's willingness to work and save. Effects on allocation of resources: Public expenditure affects allocation of resources between different uses and regions. a) Diversion of resources among different uses - Government expenditure has a tendency to divert a nation's resources from private to public use. Such diversion may affect production and productive capacity in the economy. Public expenditure on education, transport, communication, agricultural development, will benefit a very large number of people and will increase their1 productive efficiency. Expenditure on setting up public enterprises will lead to exploitation of unutilized resources and generate employment. Therefore, it is believed by many that if resources are diverted from private use to public use, there will be a greater impact on productive capacity of a much larger number of people.

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b) Diversion of resources among different regions: Public expenditure can help divert resources to backward regions and reduce regional inequalities. Government can invest in such regions by setting up public enterprises and creating infrastructural facilities. Also the private sector can- is given concessions and subsidies for investing in backward regions. Effects on Distribution: Inequalities of income and wealth distribution cause social injustice and distort production and employment patterns. Public expenditure is used by most governments as an important policy instrument to reduce inequalities. Expenditure on social security and subsidies to the poor are aimed at increasing their real income and purchasing power. Public expenditure on education, communication, health has a positive impact on productivity-of the weaker section of society, thereby increasing their income earning capacity. In order to reduce income inequalities, governments should resort to progressive public expenditures. Such expenditures provide greater benefits to people whose incomes are smaller. Old age pension, social insurance, food subsidies are progressive expenditure. However, highly progressive public expenditure may have an adverse effect on willing to work and save of those who benefit from such expenditures. Also, to support public expenditure, the government may impose highly progressive taxation. This can also have an adverse effect on ability and willingness to work, save and invest on those who are taxed. All this will have a negative impact on economic growth. This conflict between growth and income redistribution has to be tackled by the government by adopting a rational public finance policy that can help strike a balance between the two. Effects on Consumption: A rational government expenditure policy generates income, output and employment in the economy. This in turn reduces inequality of income and wealth and the level of consumption tends to rise. Moreover, government expenditure provides public goods for joint consumption like, transportation, public health, public parks and libraries. Effects on Economic Stability: Economic instability takes the form of depression, recession and inflation, all of which can harm economic growth. Public expenditure is used as a mechanism to control instability. The use of the budget to control economic instability is referred to as compensatory finance. Developed economies often experience recession, caused due to lack of effective demand. Sometimes effective demand falls due to decline in private investment. At tiniest of depression, in an industrialized developed economy, there is idle productive capacity on one hand and unemployed human resources on the other. Under these circumstances, increase in government expenditure on public works or any other type of investment will lead to manifold increase in income and employment through the process of multiplier. According to J.M. Keynes, government expenditure during recession will boost aggregate demand and this in turn will cause fuller utilization of productive capacity and unemployed manpower resulting in
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expansion in volume of production, employment and national income. During such time the government should adopt deficit budget. During inflation, the reverse policy needs to be adopted. Inflation is usually caused due excess of money supply, resulting in excess aggregate demand. Reduction in government expenditure will help to control money supply and aggregate demand, bringing down the price level. The government should follow surplus budget during inflation. Effects on Economic Growth: In developed countries, public expenditure plays a significant role in maintaining economic stability and effective demand, encouraging new investments in order to maintain a steady rate of growth. In developing countries, public expenditure in the form of investment in public enterprises, infrastructure projects, subsidies to industries and export sector, all go a long way in promoting economic growth. Thus, modern economies have all experienced tremendous growth in public expenditure due to the factors examined above. It is absolutely necessary for governments to formulate rational public expenditure policies in order to achieve the desired effects on income, distribution, employment and growth.

Trends in deficits of central government

Introduction In a developing economy, demand for resources for providing the economic and social infrastructure needs have to be balanced with its resource generating capacity. Since the sectoral claims on resources are enormous, there is often a danger of wastage leading to fiscal imbalances endangering macro fundamentals of the economy. At the beginning of reforms in 1991, the fiscal imbalances were identified as the root cause of the balance of payments crisis and domestic inflation. The fiscal consolidation, which followed in response, however, failed to sustain itself as it lacked a statutory mandate and the required institutional support. The enactment of Fiscal Responsibility and Budget Management Act (FRBMA), 2003 provided the required mandate and lent creditability to the fiscal reforms process.

A major cause of the 1991 economic crisis in India was the high fiscal deficits in the late 80s. The firefighting measures initiated this result in controlling the fiscal deficit to some extent but the recovery was also short lived. With the slowdown of the reforms since 199697 the fiscal slippage continues and the fiscal deficit has been consistently rising.

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1990-1995
More than the size of the fiscal deficit, what is disconcerting is its composition in terms of revenue and primary deficits. Firstly, the fiscal deficit appears to be driven more by revenue deficits especially in the 90s. There was a time when revenue balances used to turn out to be surpluses, though not large. In recent years, however, the deficit on the revenue account constitutes as much as one-third of the fiscal deficit. Revenue deficits imply preemption of private savings for government consumption and tend to crowd out private investment without corresponding increase in the capital spending by the government. Secondly, the deteriorating share of primary (or non-interest) deficit shows that a significant part of the fiscal deficit is due to the burden of servicing the past debts. In 198081 about one-third of the fiscal deficit was due to the debt-servicing burden. By 199091, the share of the debt-servicing component went up to over 50 percent. And currently about two-thirds of the fiscal deficit is caused by the past debt-burden. Non-tax revenues of the Centre as a proportion of GDP registered an increase during the 90s, but the increase has been far from adequate to neutralize the adverse impact of the fall in tax revenue growth. On the whole, non-tax revenue growth has practically stagnated at both levels of government during the 90s

1995-2000
There was an upward trend for two years, 199495 and 199596, but it was short-lived. While trends in the consolidated deficit indicators were dominated by those of the Central government up to 199697, the recent deterioration is predominantly due to adverse trends in States too. In general, the rise in the combined fiscal deficit has been due to both revenue shortfalls and expenditure overruns. Revenues fell short of budget targets largely due to lower tax collections particularly, Central excise and customs. Excise revenues were affected by slow industrial growth, while customs revenues were affected by lower external trade and deteriorating import unit values (particularly for petroleum products). Further, corporate and personal income tax collections were below target. The drop in the growth of Central taxes affected the flow of tax devolution to the States as well. The growth of revenue in terms of tax buoyancies with respect to GDP had decelerated even before the onset of the recessionary phase of the economy. Tax reform, while no doubt helping to introduce some rationality in the tax structure apparently had a dampening effect on the Centres revenue, as the impressive growth of direct taxes could not fully compensate for the drop in customs and Union excises that took place in the post-reform period.

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The dip in tax buoyancy occurred as revenue from sales tax, the principal component of their own tax sources, showed a deteriorating growth trend owing to tax competition among the States to attract trade and industry. Between the two principal sources of non-tax revenue, the poor financial performance of public sector enterprises has been a drag on the government finances in India. Approximately, INR 3,500 billion of investment (INR 2,300 billion in Central sector and INR 1,170 billion in State sector) is locked up in public sector enterprises in the form of equity or loans. The recovery from State level undertakings like electricity boards, transport and commercial undertakings has been especially low. The performance of Central Public Sector Undertakings (CPSUs) is slightly better than those of States as 127 out of 237 CPSUs made profits, mostly in petroleum, telecommunication and financial sectors. Studies show that the average rate of return on capital invested in State Electricity Boards (SEBs) that account for the bulk of the States investments in PSUs has been persistently negative. State road transport undertakings (SRTUs), the other major enterprise of the States, also has been a drag on their budgets, reflecting organizational inefficiencies and uncompensated burden of social obligations on the other. In several States the SRTUs are in extremely bad shape, with the bulk of their fleet of buses off the road and employees going without pay for years. It is evident that the low returns and draft on budgetary resources by the PSUs have been one of the structural factors underlying our weak public finances. Another basic problem has been the poor cost recovery of public services. According to a study carried out at the National Institute of Public Finance and Policy (NIPFP), for the years 199596 and 199697, recovery rates were as low as 8.4 percent of the costs for social services provided by the Centre and 16.6 per cent for economic services implying subsidization varying from 91 to 83 percent of the costs. The enhancement of non-tax revenue requires levying appropriate user charges on social and economic services rendered by the State governments, periodical revision of tariff by electricity boards and fare structure of road transport corporations. In the area of irrigation, efforts are on towards decentralization of water management especially through participative approaches and upward revision of water rates. On the expenditure side, the items with significant rise have been interest payments, defense expenditure due to the border conflict with Pakistan in 1999, higher wage bill associated with the 5th Pay Commission awards, emergency assistance for calamity relief to States such as Orissa, Gujarat, Andhra Pradesh, rising fertilizer subsidies and the high costs of maintaining large grain stockpiles and a subsidized public distribution system as a measure of food security. The salaries and pensions of government employees rose sharply from 199798 following the implementation of the wage adjustments recommended by the 5th Pay Commission3.

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Currently, salaries and pensions account for over 20 percent of the revenue receipts of the Centre as against 17 per cent prior to the revision. More than the salaries, the pensions bill has registered rapid growth in the 90s. In several States, salary related expenditures absorb over two-thirds to three-fourths of their revenue receipts. Apart from aggravating the budget imbalances, the sharp rise in salaries has resulted in inadequate provision for spending on materials essential for running public services efficiently and maintaining assets in workable conditions Not only are these expenditures committed, they are also downward sticky and difficult to control. Consequently, States also resort to the soft option of cutting capital outlays. This has adversely affected the allocation of adequate resources for education and health sectors, which are the primary responsibility of the States. The interest and debt-servicing expenditure increased steadily throughout the decade. Large interest payments resulting from higher borrowing and the rolling over of maturing domestic debt at higher interest rates as also the on-lending to State governments against small savings collections. Continuous accumulation of debt has entailed growing burden of debt servicing, with interest payments accounting for 52 per cent of the net revenue receipts of the Centre. The rate of interest on the other major constituent of domestic debt of the government namely the liabilities on public account (small savings and provident funds) also registered a significant increase and their share in the government debt went up from 36 per cent to 45 per cent over the same period. Direct subsidies has come down to less than 1.5 percent of GDP at present (199900); they still form 14.3 per cent of the Centres revenue receipts.

2000- 2008
With both the Centre and the States resorting to borrowing over the last two decades to finance even a part of their current expenditure, the level of indebtedness of the government has gone up significantly and stood at a little above 65 per cent of GDP in 200001. More important, the growth of domestic debt continues to outpace GDP growth pointing to the unsustainability of the fiscal deficits. The Central governments deficit is mostly financed from higher domestic market borrowing although the small saving collections were also an important source of funding. While total liabilities of the Central government including small saving deposits, provident funds, stood at 50 percent of GDP by the end of the year 200001, about 26 percent were in the form of domestic securities and loans, largely held by public sector banks and financial institutions. All this resulted in significant shortfalls in capital expenditure. The Central governments capital expenditure as a proportion of GDP has declined from over 6 per cent in the
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eighties to an average of about 4.6 per cent in the first half of the 90s and 2.6 per cent 200001. It must be recognized that the imbalances in the Government finances are also reflective of institutional rigidities and structural constraints in the division of resources and expenditure responsibilities between the Centre and State governments The fiscal deficit of the centre as a proportion of GDP came down from 5.9% in 2003 to 3.4 % in 2006-07 and is estimated to further decline 3.3 % in 2007-08(BE) (3.2 5 based on revised GDP estimates). Similarly, the revenue deficit declined from 4.4 % in 2002-03 to 1.9% in 2006-07 and is estimated to further decline to 1.5 % in 2007-08(BE). The revenue deficit as a percentage of fiscal deficits has declined from 79.7 % in 200304 to 56.3 % in 2006-07 and is further estimated to improve to 47.4 % in 2007-08(BE) implying a progressively better utilization of borrowed resources towards asset creation.

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