Budget.

What is budget?

It is a predicted amount of receipts and expenditures of Government in a financial year. Budget needs to be specified because the requirements of our country is manifold but we , like every other country have limited resources. So, budget helps us to allocate our expenditure in the best possible way such that india reaches the cusp of development.

Is the word budget mentioned in our Constitution? Is it?

No, the word budget finds no place in the Indian Constitution. Instead the term Annual Financial Statement has been mentioned in Article 112.

It basically gives a fair idea of the expected receipts and expenditure of the government in the coming FY.

Where is the Annual Financial Statement laid down?

It is laid down in the Parliament.

What are the components of a budget?

-Expenditure and receipts.

-Revenue and capital.

Define capital.

The outflow that creates an asset or reduces liability.

For example, the defence equipment that is there is Russia can be obtained by India.

-This will act as a capital,yielding returns for us in the future. (especially if we get to blow Pakistan into smithereens , into something finer than volcanis ash)

Define capital and revenue expenditure.

The outflow that creates an asset or reduces liability.

Capital expenditure leads to the creation of capital asset.

Any expenditure that is not CAPEX is called revenue expenditure. Revenue expenditure se roz ka kaam hota he. Kuch naya nahi banta. Mera matlab, mano baadme jab tum india ka best coaching centre khada karoge, jitne bhi dhanrashi tumne kharch kiye honge uss paar saare capital expenditure honge.

But the money you spend on food, rent and going to movies is revenue expenditure. Because out of that you are not creating anything tangible.

What are receipts? How do you differentiate between revenue receipts and capital receipts?

The money obtained due to increase in liability or reduction of an asset is called capital receipt.

For example, you sell your house. You will receive some money. This money is capital receipts. Why ?because it leads to reduction in an asset.

For example, you take loans from a bank. You obtain some money and increase the liability. The loan is a liability right, cause it is a responsibility that you will have to take care of in the future.

Define tax revenue and dividend.

The revenue that the Government gets from source of taxes.

The revenue that government gets from non-tax payments are dividends.

Dividends, as you know, the return that an equity shareholder gets when the company which he paid, profits.

What are the types of budget?

Balanced budget. Income=Expenditure

Surplus budget. Income>Expenditure

Deficit budget. Income<Expenditure

What is fiscal deficit?

Revenue expenditure+Capital expenditure. Excluding borrowings.

RE+CE-(CR+RR)

-Why are we excluding borrowings?

-Because let’s say that you have Rs 800. You go to the market, jumping up and down in happiness, imagining the beautiful dress you would buy. And the moment you see the price tag in the shop, it says, Rs 1000. Alas! All is lost. You need Rs 200 more. You immediately call me and tell me to transfer the amount.

Now what you add up the receipt. That is 1000 . You add up the expenditure. Now if you subtract the capital expenditure from total receipt. You get zero. Now it doens’t really show how much money you borrowed right? It doesn't really show to what extent you fell down just for a mere dress.

Now if we subtract Rs 200 from 0 we get -200.

This, my love, is called fiscal deficit.

Define primary deficit.

Primary deficit is equal to fiscal deficit-interest payments.

Let’s break it down simply:

1. Primary Deficit

• The primary deficit is the difference between the government’s fiscal deficit and its interest payments.

• It shows how much the government is borrowing excluding the burden of past loans (interest payments).

• Formula:

Primary Deficit=Fiscal Deficit−Interest Payments\text{Primary Deficit} = \text{Fiscal Deficit} - \text{Interest Payments}

👉 Example:

• Suppose fiscal deficit = ₹500 crore.

• Interest payments = ₹200 crore.

• Then primary deficit = ₹500 – ₹200 = ₹300 crore.

This means that out of ₹500 crore borrowed, ₹200 crore is just to pay interest on past loans, and ₹300 crore is for current expenditure.

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2. Interest Payments

• These are the payments the government makes on its past borrowings (public debt).

• They are not repayment of the loan principal, but only the cost of borrowing.

• For India, a large chunk of government expenditure goes towards interest payments, making it harder to spend on development projects.

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✅ In short:

• Interest payments = servicing old debt.

• Primary deficit = fresh borrowing requirement (ignoring old debt interest).

Do you want me to also explain how primary deficit indicates government’s fiscal health?

Define effective revenue deficit.

Revenue receipts-Grants for creation of capital assets.

Good question 👍

Effective Revenue Deficit (ERD)

• Revenue Deficit = Revenue Expenditure – Revenue Receipts.

• But some part of revenue expenditure is actually spent on capital formation (e.g., grants given to states/local bodies for creating assets like roads, schools, hospitals).

• Such spending, though classified as “revenue expenditure” in government accounts, creates assets in the economy.

👉 So, Effective Revenue Deficit is calculated by removing (subtracting) this asset-creating expenditure from the total revenue deficit.

Formula:

Effective Revenue Deficit=Revenue Deficit−Grants for Creation of Capital Assets\text{Effective Revenue Deficit} = \text{Revenue Deficit} - \text{Grants for Creation of Capital Assets}

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Why it was introduced?

• To give a clearer picture of how much of the revenue deficit is truly “unproductive” (like salaries, subsidies, interest payments) and how much is actually contributing to long-term asset creation.

• Recommended by the Rangarajan Committee (2011–12 Budget) in India.

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✅ In short:

• Revenue Deficit includes all revenue expenditures.

• Effective Revenue Deficit excludes the asset-creating part, so it shows the “real” unproductive gap.

Would you like me to give you a numerical example (with receipts and expenditures) to make this clearer?

Define internal and external borrowing.

Government raises the money from the domestic territory.

In case of external borrowing, the money raises the finances from foreign sources.

How does Government manage the finances?

-Internal borrowing

-Borrowing from the foreign government

-Printing currency.

Let’s say that the government misuses the deficit financing facility. Can action be taken against it? Or is there anyway to prevent the misuse of deficit financing facility by the government.

Yes, an act called the FRBM act was introduced during 1991 to limit thr governments spending.

-Privatisation was promoted.

-Debt/GDP ratio shot up during that phase.

-From 1999-2009, India was known as the top borrowing country.

To prevent the misuse of the deficit financing facility, Fiscal responsibility and budget management Act, 2003 was introduced.

So now, along with the Annual Financial statement, the government had to submit three other documents.

-Speicification of medium term fiscal policy statement.

-Specififations of macroeconomic framework statement.

-Specifications of fiscal policy strategy statement.

-It provided for presenting the figures.

Was there any committe to suggest reforms in the FRBM Act, 2003? What were the recommendations?

It was the N. K Singh Committe.

-Debt to GDP ratio=38.7 for central government and 20 percent for state government.

-Fiscal deficit target to be 2.5 percent of GDP by FY 22-23.

There should be an escape clause.

For natural calamity or pandemic because government is not always bang on target all the time.

What are the advantages of deficit financing?

Taxpayer is not impacted.

-It prevents inflation. (it is a tool for controlling inflation)

-Strengthens government Financial position.

-Pushes the government to use unemployed resources.

-It is the RBIs prerogative to control inflation in India but also inflation can be controlled by changing the fiscal policy.

How does deficit financing help when government takes loan from RBI?

-Government says “naye notes chaap do”.

But RBI doesn’t do it for free. It takes interest. RBI profits from the interest.

-If the profit becomes surplus or beyond a certain limit, the surplus has to be transferred to the government.

-So governments position is strengthened.

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What is monetization of deficit?

It is the magic wand. Monetization of deficit is said to have happened if government requests the RBI to print money.

What are the two types of monetization?

Direct and indirect.

What is the difference between direct and indirect monetization?

Direct monetization should be the last resort because, most likely it adds in cash to the circulation without adding equivalent value of goods and services. So it always, almost always leads to inflation.

-In indirect monetization there is no issuance of new currency notes.

Who has the responsibility of monetization?

Before 1997 , during times it deficit it was the duty of RBI to monetize the deficit.

-After 1997 this was put to a halt. The onus was shifted to the Government.

-For RBI automatic monetization stopped in 1997.

Why does RBI have to pay dividend to the government every year?

Because ultimately RBI is owned by the government. If RBI profits from banking operations, then the it is it’s duty to transfer some dividend to the government. I hope you remember the definition of dividend.

Is deficit always bad?

No, probably not. Sometimes it can be good also. If the deficit creates capital asset then it can be considered good.