Every year there is a lot of buzz around the budget that is presented by the Government of India. The entire nation stands still when the finance minister of India starts putting projections for the upcoming year. The stock market is super volatile in the close by sessions.
'How much will be spent on which sector?', 'how much will India Inc. earn?', 'what's in for the poor?', 'what's in for the agriculture sector?' .......the questions keep flowing. The bank rates, imports-exports, businesses, production in the year ahead are adjusted according to the set budget and flexibility provided. Budget sets the tone for the economy in the upcoming fiscal year.
Wouldn't it be great if each one of us just had a little idea and could understand what is the basis for the government to take some particular decision?
It is very important to know the basics before jumping deep into any stuff. That's the motive of this article on "Basics of Government Budget".
Government Budget is an annual budget showing item wise estimates of receipts and expenditures for the forthcoming fiscal year. (Fiscal year is taken to be from Apr 1 of the current year to Mar 31 of the next year.)
COMPONENTS OF A BUDGET
A Government or Union Budget mainly has four components:
- Revenue Receipts
- Revenue Expenditures
- Capital Receipts
- Capital Expenditures
The above four components can be divided based on two different criterion:
Why are there two different criterias? Does it seem confusing? Let us simplify things.
From the above four terms let's take out two words: Revenue and Capital
In general, Revenue transactions means 'recurring transactions'. In accounting terms, any transaction done on a very regular and recurring basis is put into the revenue category. Whether it is paying wages (it's done daily or weekly or monthly), or earning salary (which is received like, monthly or something), it comes under the revenue category.
On the other hand, Capital transactions means 'non-recurring transactions'. Again, in accounting terms, any transaction that will not happen very often, it's not a part of everyday functioning of a place or person, is put into the capital category. Let's say, taking a loan (of course you will not be availing for a loan everyday or every month....that's not possible), or cost incurred for renovating your home (that also happens once in a some years or something).
Moving onto the other two terms: Receipts and Expenditures
These are pretty straightforward.
Receipt is when you receive and Expenditure is when you spend.
I hope it's clear now. Let's see what we can make out by joining the terms.
We'll be grouping the terms based on the 'flow of money'.
What are Budget Receipts?
Budget receipts are the estimated money receipts of the government from all sources during a particular fiscal year.
Revenue Receipts: refer to those receipts which occur regularly and recurrently in the normal course of working of a government. Thus, they are also called Current Receipts.
Now another important point to add is that receipts that come in this category do not create any liability nor lead to reduction in any asset.
Example - Tax revenue (Direct Tax, like Income tax, Corporation Tax and Indirect Tax, like GST, Custom duty, Excise duty), Non - Tax Revenue (Profits and dividends from PSU, Fees of various services the government provides, gifts and grants from other countries, fines and penalties on citizens, etc.)
Capital Receipts: refer to those those receipts that are non-recurring and non-routine in nature. These receipts are based on the more strategic decisions of the government.
Example - Borrowings (Issue of government bonds, open market operations, loans from the World Bank or IMF, etc.), Recovery of Loans (Loans that the central government provides to various state governments and union territories), Disinvestment in PSUs, and funds from the Small Savings.
Very important to note: These either create some kind of liability or cause a reduction in the assets of the government.
Note: The part in italics forms a major difference between the two.
What are Budget Expenditures?
Budget expenditures are the estimated expenditures of the government during a particular fiscal year.
Revenue Expenditure: refer to those expenditures which are incurred regularly and recurrently in the government's normal course of work. They are also called Current Expenditures.
Example - Payment of salaries of government employees, payment of pensions, interest on borrowings, etc.
Such expenditures do not create any asset nor reduce any liability of the government.
Capital Expenditure: refer to those expenditures which are non-recurring and non-routine in nature. These are incurred as per some strategic decisions of the government.
Example - Loans provided to states and union territories, expenditure on big projects (like, building roads, hospitals, etc.), Repayment of borrowings, Redemption of any issued bonds, etc.
Such expenditures either create some assets for the government or reduce their liabilities.
Note: The part in italics forms a major difference between the two.
GOVERNMENT DEFICIT
What is 'Deficit', in the most simple words?
When expenditure is more than the income.
Thus, going with this.......
Budgetary deficit happens when the government spends more than it earns. It is defined as the excess of total estimated expenditure over the total expected earnings.
This budgetary deficit is also sectioned into different parts:
1) REVENUE DEFICIT
As the term suggests, it refers to the excess of revenue expenditure over the revenue receipts during the given fiscal year.
Revenue Deficit = Revenue Expenditure - Revenue Receipts
Okay, so when we ever hear in news that there is a revenue deficit in the country (which has been the case for India for quite a long time now), what do we make out of it?
- First of all, it means that the government is unable to meet its everyday normal functioning expenditures using its revenue receipts.
- This definitely means that the government is unable to save for the future. In fact, since the government has to work everyday, the costs incurred in this everyday working is being financed from somewhere else.
- There high chances that the government will make up for this deficit from its capital receipts. This means that the government is either taking a borrowing or probably selling its assets to do so (like selling its stake in a PSU).
- This tells us that the government is spending more than it should ideally spend. This excess spending leads to an inflationary like situation in the economy or if amount is being borrowed, it increases future burden to pay interest and return the amount when tenure of the loan is over.
- In such a case, the government should reduce its expenditure or increase it revenue receipts.
2) FISCAL DEFICIT
This term is very frequently talked about in the economy.
It refers to the excess of total expenditure over total receipts (excluding borrowings) during the given fiscal year.
Fiscal Deficit = Total Expenditure - Total Receipts (excluding borrowings)
You might be thinking why are borrowing excluded from fiscal deficit........
We'll talk about it ahead.
Right now let's focus on 'What does this signify?'
- This measure of deficit shows in total how much more is the government spending than its total receipts.
- Fiscal deficit also indicates the borrowing requirements of the government.
- Government also borrows from the central bank to meet its fiscal deficit. It sells its securities for which the central bank pays money. To make the payment, the central bank prints new money. This process is also known as 'Deficit Financing'. This increases money supply in the economy and creates inflationary pressure.
- It casts a doubt over future growth as instead of saving for the future, the government is busy collecting money and paying interests.
The Vicious Cycle
To fulfill the fiscal deficit, the government borrows money. Such borrowing not only involve repayment of the borrowed amount but also the interest levied on it. This interest payment increases the revenue deficit. Again to finance the revenue deficit, government takes further loans.
You see the cycle here! This is known as 'Debt Trap'. India is still managing it some how, but if we talk about our neighbour Pakistan, they are completely in a debt trap.
Okay so now let's come to the question, 'Why are borrowing excluded from fiscal deficit?'.
The government receives the borrowed money. If it is included in the fiscal deficit, it would be added as an income which it is not. It is a liability which has to be paid back and thus, is not taken as a receipt and excluded from the fiscal deficit. Also this helps us to measure the actual expenditure and the actual receipts of the government, which tells how much money is required for the government to borrow.
In reality, since India is a developing nation, it cannot completely nullify its fiscal deficit. Since, India (or for that matter, any developing nation) has to spend in order to improve infrastructure, build better roads, improve facilities, etc. its expenditure will always be more than receipts, till the time the economy matures. But still, deficit can be controlled which needs to be worked upon.
Another fact: Fiscal Deficit is usually mentioned as a percentage of GDP.
The ideal fiscal deficit of India should be around 3% of the GDP, as per FRBM (Fiscal Responsibility and Budget Management). But as per the 2019-20 report, India's fiscal deficit is 4.59% of the GDP. After that 'Covid' happened and the economy's outlook has become even more worrying. So there is lot of work to be done.
3) PRIMARY DEFICIT
Primary deficit refers to the difference between fiscal deficit of the current year and the interest payments on the previous borrowings.
Primary Deficit = Fiscal Deficit - Interest Payments
What does it show?
It shows that if we deduct the interest payment requirements on our previous borrowings, how much is the real deficit. This helps to highlight the deficit which is due to core expenditures and receipts other than the interest payment.
Why does this deficit really exist?
All major countries have some borrowing from other international institutions, from other countries. These borrowing have some interest payments attached to them. If government lingers on repayment of these borrowings, the interest payments attached can become massive. So, primary deficit acts as an alarm to remind government to repay the borrowings as early as possible to prevent interest obligations on them to become massive.
These interest payments then also lead to increased fiscal deficit.
If suppose this Primary deficit comes out to be zero or very low,
then this means that almost entire fiscal deficit of the country is just interest payment.
A live example of this can be taken as when Sri Lanka struggled to repay the borrowings from China due to long standing political uncertainty and economic issues within the country. In 2017, it had to sacrifice one of its strategic locations, 'Hambantota Port' to China for 99 years! Yeah, if you are not aware......this really happened.
THE THREE TYPES OF GOVERNMENT BUDGETS
Every year budgets have to be planned. There are three main structures of Budgets based on which further decisions can be made. Let's discuss about them now.
Very well written💯
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