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February 11, 2020 Tuesday 04:10:05 PM IST

Decoding The Budget

Finance

Most of us has heard about budgets and most financially literate families maintain a budget to track the expenses and revenue in a month. A few of us may jot down the our monthly income and expenditure in a notebook. Now let’s think of a nation with 1.3 billion people represented by a government which has to take care of its citizens by providing them nutrition, security, safer environment to work and invest. To oversee such activities, the government might charge from 1.3 billion some service charge. Now let’s call the service charge which the government receives as the revenue and the services government provides as expenditure.

 In short a union/ state/ municipal/ panchayat budget is an estimation of revenues and expenditure over a specified future period of time and is usually compiled and re-evaluated on a periodic basis.

Background of the budget formation

Before we understand the budget making, we require a bit of understanding of how economic activity is measured in a country and what is the role of budget in the process.  In the accounting framework, the GDP (Gross domestic product) of a country measures all the economic activity in a country. One of the methods used is expenditure method which puts the total expenditure into four compartments. For example, assume India’s GDP to be Indian Rupees (INR) 2 trillion.


We can compartmentalize the INR 2 trillion into expenditure occurred by consumers in consumption C (What is used for consumption by households and firms in an year), in investment I (The amount of investment performed by households (new houses) and corporates in an year and expenditure on imports and earning from exports NX (The expenditure on amount of goods and services exported minus the amount of goods and services imported in an year).

The last component the government expenditure is our subject of interest, i.e how much expenditure on goods and services is performed by government. However, the expenditure on goods and services by the government will be decided based on the based on the performance of the C, I, and NX. Typically, the government expenditure on goods and services in Indian economy is around 10% of the total GDP.

Let’s have a hypothetical scenario to understand this better. Imagine our country is going through a recession (downturn). The first two components which occupies 85% of the total GDP is likely to suffer. A recession where jobs are few and economic activity is low, fewer households will consume more as they have lesser income. Fewer households will buy a house as an investment and few firms will expand the business as there is hardly any demand from the market. The imports are likely to be low while exports can remain stable depending on the global growth. This means C+I+NX has fallen from last year/ last quarter which is reflected as a fall in the growth rate of GDP.

No government likes to show a fall in the GDP in the regime and they use our fourth component to arrest or mitigate the fall in GDP. The G (government expenditure on goods and services) is typically raised so that the fall in consumption and investment section is partially arrested.


Now before every budget session, the Finance Ministry looks at the trend of C, I and  NX in the past quarters and also pays attention to the forecasted values of C,I,NX in the coming quarters. If the country is having a good GDP growth, then the government expenditure on goods and services will be reduced as higher allocation of this specific component is not required to maintain GDP growth. On the other hand, if we are facing a recession and we have enough information on the forecast of C, I and NX that we cannot expect consumption, investment and net exports expenditure to boom in the coming quarters, the onus of lifting the GDP will be in the hands of government expenditure. This expenditure will be reflected in the budget of the country in the form of expenditure for various programs including defense, childcare, education, health. The revenue which is required to oversee such expenditures is generated through various taxes and non-tax revenues and the estimates of the same will be mentioned in the budget. This is broadly refers to as the fiscal policy of the country and therefore budget are the veins through which the fiscal policy. That is how much G must be increased or decreased according to the economic environment of the country.

 In short, the budget contains three types of accounts actual for the preceding year, revised budget estimates for the current year and budget estimates for the coming year, where the former two accounts allows the social planner ( government) to design how much must be spent on the coming year.

The three stages of making of a budget are: Preparation, Enactment and Implementation of the budget.

Preparation of Budget


The government budget comprises of Revenue budget and Capital budget where the former consists of how a government plans to raise and spend its revenue. On the other hand, government allocates a part of its capital revenue which it receives from market loans, loans form RBI and foreign loans for capital expenditure (typically involving physical capital building like infrastructure development.) to various stakeholders including state governments, government enterprises like ministry of highways and other corporations to undertake infrastructural activities.

A expenditure preparation statement in detail is provided in the flowchart.

Insert flow chart here INSERT PPT 2

The process for preparation of expenditure estimates for the budget starts with the issue of the 'Budget Circular'. The Financial Advisers forward this circular to the Ministry/Department and subordinate offices and the Ministries in turn collect the estimates from the organizations/ subordinate offices under their control and also prepare the same for their own activities. These estimates are scrutinized by the 'Budget Units' of the Ministries and submitted to their Financial Advisers.The Financial Advisers review and examine the estimates before consolidating them under different heads of expenditure.These Consolidated estimates  send by The Financial Advisers, to the 'Budget Division' of the Ministry of Finance are classified under separate 'Demands for Grants' in details up to the 'Object Head of Classification' and labelled as the 'Statement of Budget Estimates'


Then these are discussed by the Secretary Expenditure (Ministry of Finance) with each Financial Adviser in a series of meetings where Ministry's 'Budget Division' is also represented. Budget Division' in the Ministry of Finance conveys budget ceilings to each Financial Adviser for revising all the estimates within the ceilings and obtaining 'Statement of Budget Estimates' in the final form. Meanwhile, the Controller Aid Accounts and Audit (CAA&A) also send the estimates on external debt, repayment of external loans and other payments.The final 'Statement of Budget Estimates' are to be sent to the 'Budget Division' in two stages. In the first stage, the 'Statement of Budget Estimates‘ includes:-Revised non-plan expenditure for the current year and budget estimates for the next year; Revised plan expenditure for the current year.At the second stage of the 'Statement of Budget Estimates' Financial Advisers sent to the Budget Division of the Ministry of Finance, the budget estimates for plan expenditure for the next year.

Now that we know how much of government expenditure is required to maintain the GDP of the economy intact, the government also looks at the possible sources of revenue to fund these expenditures.

FLOW CHART here ON PPT SLIDE 3

The 'Budget Division' of the Ministry of Finance obtains revenue estimates for the next year from many organizations as indicated in the figure above.These organizations and estimates collected are as under:


⮚      Central Board of Direct Taxes in the Department of Revenue of Ministry of Finance - Estimates of Direct Taxes;

⮚      Central Board of Excise and Customs in the Department of Revenue of Ministry of Finance - Estimates of Indirect Taxes;

⮚      Financial Advisers of Central Ministries - Estimates of various receipts including those of non-tax revenue, capital receipts and receipts of account of public account;

⮚      Reserve Bank of India - Estimates of Public Debt transactions;


⮚      Controller of Aid Accounts and Audit - Estimates of External Assistance;

⮚      State Accountants General - Estimates of recoveries from States on account of Loans and Advances from the Union Government;

⮚      Chief Controller of Accounts and Accounting Offices - Estimates of taxes and receipts of the Union Territories

The Budget division obtains estimates on possibilities of revenue from the above mentioned ministries as well as sources of market borrowings from the Reserve Bank of India which may be required by the Government. This process continues till the finalization of the budget as the various alternatives to fill the gap between receipts and disbursements are to be worked out till the end.


If the economic growth of the country is low, there is lesser products sold, lesser income to be taxed and lesser non-tax revenues like licenses and registration of new companies can be obtained. In these cases, the country borrows from external sources or from RBI. In the last year budget, the government borrowed from RBI a sum of 1,760000 lakh crores mainly due to the shortfall in other possibilities of revenue generation.


Deficit budgeting

Though it is imperative that budget document should ensure that the expenditure and revenue figures must tally, most governments tend to spend more than the receipts culminating in fiscal deficit. Unchecked expenditure measure based on populist programs in the past had put stress on the government finances and therefore an Act is passed by the government to keep the expenditure in check. The Financial responsibility and Budget Management (FRBM) Act recommended that the government should target a fiscal deficit of 3 per cent of the GDP in years up to March 31, 2020 cut it to 2.8 per cent in 2020-21 and to 2.5 per cent by 2023. It has to keep the revenue deficit and capital (difference between revenue/capital expenditure and revenue/capital receipts)low. As the economy progress, it is natural that the receipts will overtake the expenditure which explains the lower percentages at 2020-21 and 2023.


The second step is Enactment of Budget where the budget is presented on the first working day of February, followed by a general Discussion for 4 to 5 days. A session interval is initiated where the demands of administrative ministries are referred to different Departmental Standing Committees of the Parliament where the demands are scrutinized, and report is prepared. After the session interval ends in the Parliament, a discussion on demands for grants takes place where motions for policy cuts, economy cut and token cut can be brought out. Additional appropriation bills relating to non-votable part of expenditure.  Post these discussions the voting happens on the budget.

Implementation of the Budget

The implementation of the budget involves two main operations: commitments and payments. As regards the commitment of expenditure, a decision is taken to use a particular sum from a specific budgetary line in order to finance a specific activity.Once the corresponding legal commitments (e.g. contracts) have been established, and delivery has been made of the contractual service, work or supplies, the expenditure is authorised and the sums due are paid.

 


Activity for students

 

Since Indian economy is in a recession do you think we can expect higher government expenditure in the coming budget?

 


However with lower revenue and capital receipts in the past and future quarters requires some borrowings. Where do you think Indian government will borrow? Will it lead to more disinvestment of public companies like Air India?


Dr Ashok Thomas

The writer holds a PhD in Economics from University of Pisa (Italy) and is an Assistant Professor of Economics at Indian Institute of Management-Kozhikode

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