Public Finance: The Process of Budget Making

Public Finance Learning Outcomes Unit – 3: The Process of Budget Making

Objectives of the Chapter

• Define government budget and explain its need and objectives.
• Describe the budget concepts and terminologies.
• Illustrate the process of budget making.
• Detail the different sources of government revenue and expenditure.
• Elucidate the process of management of public debt.

3.1 Introduction

• Governments perform various functions such as:
  • Protecting territories.
  • Maintaining law and order.
  • Providing public goods.
  • Implementing plans for economic and social welfare.
• Executing these functions requires adequate financial resources.
• The budget is a policy instrument used by the government to regulate and restructure a country's economic priorities.

The Need for Budgeting

• Efficiently allocate limited resources to ensure maximum social welfare.
• Reallocate resources according to declared priorities.
• Ensure redistribution of income and wealth.
• Reduce/eliminate economic fluctuations for stability.
• Achieve sustainable increase in real GDP.
• Reduce regional disparities.

Definition of a Budget

• A statement that presents the details of where the money comes from and where it goes to.
• A document presented for approval and legislation by a government.
• Contains estimates of proposed expenditure for a given period and the proposed means of financing them.
• A schedule of the entire revenues and expenditures that the government expects to receive and plans to spend during the following year.
• Includes projections for the economy and its various sectors.
• Contains estimates of the government’s accounts for the next fiscal year (budgeted estimates).
• The most comprehensive report of the government's finances, consolidating revenues from all sources and outlays for all activities.

Budgetary Processes

• Union budget.
• State budget.
• Local bodies budget.
• The focus of this unit will be the union budget only.

3.2 The Process of Budget Making

• The budgetary process is the means by which the executive and legislative branches together formulate taxing and spending proposals.
• The finances of the Government of India are controlled by the Ministry of Finance.
• The budget is prepared by the Ministry of Finance in consultation with NITI Aayog and other relevant ministries.
• The budget must be presented and approved by both houses of parliament before the beginning of the fiscal year (April 1 to March 31).
• Article 112 of the Constitution provides that the President shall lay before both houses of parliament a statement of estimated receipts and expenditure of the Government of India for that year, referred to as the “Annual Financial Statement”.

Budgetary Procedures

• Preparation of the budget.
• Presentation and enactment of the budget.
• Execution of the budget.

Budget Process Activities

• Administrative process: Budget and accompanying documents are prepared in consultation with various stakeholders.
• Legislative process: Budget is passed by the parliament after discussions.

Budget Preparation Timeline

• Commences in August-September of the previous year.
• The Budget Division of the Ministry of Finance prepares a comprehensive schedule for budget preparation activities.

Steps in Budget Making

• The Budget Division issues the budget circular containing detailed instructions and formats for preparing the estimates to all ministries, states, union territories, and autonomous bodies.
• Ministries and departments prepare detailed estimates of expenditure according to their assessment of requirements for the subsequent year.
• Every department prepares estimates for receipts and expenditure separately.
• Pre-budget consultations are done by the Union Finance Minister with state finance ministers and chief ministers, various stakeholders and interest groups, including industry associations, representatives from agriculture and social and welfare sectors, labor organizations, experts from NITI Aayog, economists, etc., to elicit their suggestions on the proposed budget.

Budget Presentation

• The budget is presented in the Parliament in such form as the Finance Ministry may decide after considering the suggestions of the Estimates Committee.
• Budget documents depict information relating to receipts and expenditure for two years:
  • Budget estimates (BE) of receipts and expenditure in respect of current and ensuing financial year.
  • For the current year through Revised Estimates (RE).
  • Actuals of the year preceding the current year.

Budget Speech

• A policy document that draws attention to the proposed policies and programs of the government.
• The Finance Minister makes a detailed budget speech at the time of presenting the budget before the Lok Sabha.
• Presents details of the proposals for the new financial year regarding taxation, borrowings, and expenditure plans of the government.

Parts of the Budget Speech

• Part A:
  • Outlines the prevailing macroeconomic situation of the country and the budget estimates for the next financial year.
  • Elaborates the priorities of the government.
  • Presents a broad framework of the total funds raised via taxes or borrowings.
  • Proposed government expenditure allocations for different sectors and fresh schemes for different sectors.
• Part B:
  • Details the progress the government has made on various developmental measures.
  • The direction of future policies.
  • The government’s tax proposals for the upcoming financial year, including variations in the current taxation system.

Annual Financial Statement

• Shows the receipts and expenditure of government in three separate parts under which government accounts are maintained:
  1. Consolidated Fund of India
  2. Contingency Fund of India
  3. Public Account

List of Budget Documents Presented to the Parliament

• Annual Financial Statement (AFS)
• Demands for Grants (DG)
• Finance Bill
• Statements mandated under FRBM Act:
  • Macro-Economic Framework Statement
  • Medium-Term Fiscal Policy cum Fiscal Policy Strategy Statement
• Nine other explanatory statements supporting the mandated documents are also presented.

Expenditures Charged on the Consolidated Fund of India

• Emoluments and allowances of the President of India and his/her office.
• Emoluments of Judges of supreme courts and high-ranking personnel of constitutional bodies across India.
• These are not subject to the vote of parliament.

Budget Presentation in Election Year

• By convention, the budget may be presented twice.
• The first one is to secure a Vote on Account for a few months.
• This is followed by the Annual financial statement for that year or the full-fledged Budget.

Budget Discussion in Lok Sabha

• Two stages:
  • General discussion on the budget as a whole.
  • The house is adjourned for a fixed period.
• Demands for grants of various ministries/departments are considered by the standing committees concerned.
• Reports are presented by these committees within the stipulated time.
• The house proceeds to discussion and conducts ministry-wise voting on demands for grants.
• The Lok Sabha has the power to concur or to refuse any demand or even to reduce the amount of grant sought by government.

Role of Rajya Sabha

• The budget is laid on the table of the Rajya Sabha soon after the Finance Minister has completed her/his budget speech in the Lok Sabha.
• The Rajya Sabha does not vote on the demands for grants.
• There is only a general discussion on the budget.

Appropriation Bill

• Introduced after the general discussion on the budget proposals and voting on demands for grants have been completed.
• Intended to give authority to the government to incur expenditure from and out of the Consolidated Fund of India.
• Motions for reduction to various demands for grants are made in the form of ‘cut motions’ seeking to reduce the sums sought by government.

Finance Bill

• Introduced in Lok Sabha immediately after the presentation of the general budget.
• Seeks to give effect to the government’s taxation proposals.
• Accompanied by a memorandum explaining the provisions of the bill and their effect on the finances of the country.
• The motion for leave to introduce a finance bill cannot be opposed.
• Taken up for consideration and passing after the Appropriation Bill is passed.
• Seeks to give effect to the financial proposals of the government for the next financial year.
• The Parliament has to pass the Finance Bill within 75 days of its introduction.

Guillotine

• On the last day of the days allotted for discussion on the demands for grants, the speaker puts all the outstanding demands for grants to the vote of the house.
• This process is known as ‘Guillotine’.
• It is a device for bringing the debate on financial proposals to an end within a specified time.

Finance Bill in Rajya Sabha

• After the Finance Bill has been passed by the Lok Sabha, it is transmitted to the Rajya Sabha for Its recommendations.
• The bill being a money bill, Rajya Sabha has to return it within a period of 14 days, with or without recommendations.
• The recommendations of Rajya Sabha may be accepted or rejected by the Lok Sabha.

Recent Changes

• From 2017-18, the date of presentation of the budget has been advanced to 1st February.
• An important budgetary reform was the merger of railway budget with the general budget from the budget for financial year 2017-18.

3.3 Sources of Revenue

• The Department of Revenue of the Ministry of Finance exercises control in respect of the revenue matters relating to direct and indirect union taxes.
• The department is also entrusted with the administration and enforcement of regulatory measures provided in the enactments concerning goods and services tax (GST), central sales tax, stamp duties and other relevant fiscal statutes.

Statutory Boards

• Central Board of Direct Taxes (CBDT):
  • Looks after matters relating to the levy and collection of all direct taxes.
• Central Board of Indirect Taxes and Customs (CBIC):
  • Looks after matters relating to levy and collection of goods and service taxes (GST), Customs and central excise duties, service tax, and other Indirect taxes.

Categories of Government Receipts

• Revenue receipts:
  • Tax revenue.
  • Non-tax revenue.
• Capital receipts:
  • Debt receipts.
  • Non-debt capital receipts.

Broad Sources of Revenue

• Corporation tax
• Taxes on income
• Wealth tax
• Customs duties
• Union excise duties
• Goods and services tax including GST compensation cess
• Taxes on union territories

Centre’s Net Tax Revenue

• Total of tax revenue after paying the states’ share and the National Calamity Contingent duty (NCCD) transferred to the National Calamity Contingency Fund.

Non-Tax Revenues

• Interest receipts
• Dividends and profits from public sector enterprises and surplus transfers from Reserve Bank of India
• Other Non-tax revenues
• Receipts of union territories

Revenue from Social and Economic Services

• Social services:
  • Medical services, public health.
  • Broadcasting, education, sports, art and culture, housing.
• Economic services:
  • Communication, energy, transport, science, technology and environment, railways.
• General administrative services.

Capital Receipts

• Non-debt capital receipts:
  • Recoveries of loans and advances
  • Miscellaneous capital receipts (disinvestments and others)
• Debt capital receipts:
  • Market loans for different purposes
  • Short term /Treasury bill borrowings
  • Securities issued against small savings
  • State provident fund (Net)
  • Net external debts
  • Other receipts (Net)

Non-Debt Receipts

• Recoveries of loans advanced by the government to PSEs, state governments, foreign governments and union territories.
• Sale proceeds of government assets, including those realized from divestment of government equity in public sector undertakings (PSUs).

Debt Capital Receipts

• Comprise market loans and short-term borrowings by the government, borrowing from the Reserve Bank of India, and loans taken from foreign governments/institutions.
• Examples of ‘Other receipts’ include Sovereign Gold Bond Scheme, receipts from international financial institutions and saving bonds.

3.4 Public Expenditure Management

• Prudent and well-designed public expenditure management is essential for any government to ensure that the level of aggregate public expenditure is consistent with a sustainable macroeconomic framework.
• Developing economies like India require enormous amount of public spending to initiate and accelerate economic growth and to promote employment opportunities.
• Effective reduction in fiscal deficit requires an ingenious mix of revenue and expenditure policies.
• Public expenditure affects the allocation of resources among various uses, and therefore great care should be taken to channelize the resources to socially desirable areas.
• Public expenditure management is the process that allows governments to be fiscally responsible.
• Public expenditure programs or projects should be designed and implemented to provide given levels of outputs or achieve specific objectives at minimum cost.

Economic Costs of Unproductive Public Expenditures

• Larger deficits
• Higher levels of taxation
• Lower economic growth
• Fewer resources available for use elsewhere
• Greater debt burden in the future

Role of the Department of Expenditure

• The Department of Expenditure of the Ministry of Finance is the nodal department for overseeing the public financial management system in the central government and matters connected with state finances.
• Responsibilities:
  • Implementation of the recommendations of the Finance Commission and the Central Pay Commission
  • Monitoring of audit comments/observations
  • Preparation of central government accounts
• Assists central ministries/departments in:
  • Controlling the costs and prices of public services
  • Reviewing systems and procedures to optimize outputs and outcomes of public expenditure.

Pre-Budget Meetings

• The requirements of funds for all categories of expenditure, including various programs and schemes, along with receipts of the departments are discussed during the pre-budget meetings chaired by Secretary (Expenditure).
• Expenditure estimates are provisionally finalized and communicated to ministries/departments after the approval of Finance Minister.

Expenditure Profile

• One of the explanatory documents of the budget document is the ‘Expenditure Profile’ (earlier known as expenditure budget) consisting of relevant data across all ministries/departments to outline a profile of the general financial performance of the government of India.
• Gives an aggregation of various types of expenditure and certain other items across demands.
• The total expenditure through budget (both current and capital) of various ministries and departments is composed of central expenditure and transfers.

Classification of Central Government Expenditure

A. Centre’s Expenditure:

• Establishment Expenditure of the Centre
• Central sector schemes
• Other central expenditures including those on CPSEs and Autonomous Bodies

B. Centrally Sponsored Schemes and other Transfers:

• The transfers include
  • Centrally sponsored schemes
  • Finance Commission transfers
  • Other transfers to states
• Establishment expenditure includes establishment-related expenditure of the ministries/departments, and attached and subordinate offices.
• Central Sector Schemes (CS) include those schemes which are entirely funded and implemented by the central agencies under union government ministries/departments.

3.5 Public Debt Management

• In emerging market and developing economies, the government is generally the largest borrower.
• Government debt from internal and external sources contracted in the Consolidated Fund of India is defined as Public Debt.
• The government raises funds primarily from the domestic market using market-based and fixed-rate instruments to finance its fiscal deficit.
• Public debt, in simple words, means debt incurred by the government in mobilizing savings of the people in the form of loans, which are to be repaid at a future date with interest.
• Public debt is not a one-time exercise of borrowing and repaying.
• Debt servicing is a continuous exercise as a portion of debt falls due each month.
• The government refinances the debt, i.e. it sells new bonds and uses the proceeds to pay off holders of the maturity bonds.
• Sustainability of sovereign debt has always been an important indicator of the overall macroeconomic health of a country.
• Debt sustainability is in great part a function of the level of debt and the government’s capacity to service the outstanding debt.

Public Debt Management Definition

• The task of determining the size and composition of debt, the maturity pattern, interest rates, redemption of debt etc., by the fiscal and monetary authorities.
• The process of setting up and implementing the strategy for managing public debt in order to raise the required amount of funding at the desired risk and cost levels.

Overall Objective of Central Government’s Debt Management Policy

• To meet the central government’s financing needs at the lowest possible long-term borrowing costs and also to keep the total debt within sustainable levels.
• Additionally, it aims at supporting the development of a well-functioning and vibrant domestic bond market.

Debt Management Strategy Pillars

• Low cost of borrowing
• Risk mitigation
• Market development

Institutions Responsible for Public Debt Management

• Reserve Bank of India:
  • Domestic marketable debt i.e., dated securities, treasury bills, and cash management bills.
• Ministry of Finance (MOF):
  • External debt
• Ministry of Finance; Budget Division and Reserve Bank of India:
  • Other liabilities such as small savings, deposits, reserve funds etc.

Internal Debt Management Department (IDMD)

• The responsibility of managing the domestic debt of the central government and of 28 state governments and two union territories is entrusted with the Internal Debt Management Department (IDMD) of the Reserve Bank of India.
• The RBI acts as the debt manager for marketable internal debt.
• Treasury bills are issued to meet short term cash requirements of the government.
• Dated securities are issued to mobilize longer term resources to finance the fiscal deficit.
• From 1997 onwards, the Reserve Bank also provides short -term credit up to three months to state governments banking with it in the form of Ways and Means Advances (WMA) to bridge temporary mismatches in cash flows.

External Debt Management

• Managed by the Department of Economic Affairs in the Ministry of Finance (MoF).
• Most of the external debt is sourced from multilateral agencies (International Bank for Reconstruction and Development, Asian Development Bank, etc.).
• There is no sovereign borrowing from international capital markets.
• The entire external debt, in terms of original maturity, is on a long -term basis and a major part is at fixed interest rates.
• The risk associated with external the debt is the depreciation in the value of the domestic currency vis-à-vis the currency of denomination of external loans leading to increase in the government’s debt servicing cost.

The Fiscal Responsibility and Budget Management (FRBM) Act

• Passed in 2003 to provide a legislative framework for the reduction of deficit and thereby debt of the central government to a sustainable level.
• Objectives:
  • Inter-generational equity in fiscal management
  • Long run macroeconomic stability
  • Better coordination between fiscal and monetary policy
  • Transparency in fiscal operation of the government

Public Debt Management Cell (PDMC)

• Created in 2016 under the Department of Economic Affairs.
• The Medium Term Debt Management Strategy or MTDS 2021-24 is a framework to determine the appropriate composition of the debt portfolio.
• The objective of the debt management strategy is to efficiently raise debt at the lowest possible cost in the medium term while ensuring that financing requirements are met without disruption.

Debt Position of the Government of India

Government Response to the Pandemic

• Increased expenditure on health and social sector.
• Revenue receipts declined substantially due to the adverse effects of the pandemic on economic activity.
• Fiscal deficit widened necessitating an increase in the size of the borrowing programme significantly during 2020-21 and 2021-22 in order to render counter-cyclical fiscal policy support and to provide targeted support to segments deeply hit by the pandemic.

Reserve Bank Initiatives

• The Reserve Bank has been proactively engaged in the development of the government securities (G-sec) market including broadening of investor participation.
• As part of continuing efforts to increase retail participation in G-sec, ‘RBI Retail Direct’ facility was announced on February 5, 2021:
  • For improving the ease of access by retail investors through online access to the primary and secondary government securities market
  • To provide the facility to open their government securities account (‘Retail Direct’) with the Reserve Bank.

Budget Concepts

Balanced Budget

• A budget in which revenues are equal to expenditures.
• Neither a budget deficit nor a budget surplus exists.
• Revenue does not fall short of expenditure.
• Revenue = Expenditure

Unbalanced Budget

• The budget may either be surplus or deficit.

Surplus Budget

• When estimated government receipts are more than the estimated government expenditure.
• The government spends less than the receipts.
• Public revenue exceeds public expenditure.
• R > E

Deficit Budget

• When estimated government receipts are less than the government expenditure.
• A deficit budget increases the liability of the government or decreases its reserves.
• In modern economies, most of the countries follow deficit budgeting.

Capital Receipts

• Receipts that lead to a reduction in the assets or an increase in the liabilities of the government.
• Examples include recoveries of loans, earnings from disinvestment, and debt.

Revenue Receipts

• Receipts which neither create any liability nor cause any reduction in the assets of the government.
• Two sources of revenue receipts for the government:
  • Tax revenues.
  • Non-tax revenues.

Revenue Expenditure

• Expenditure incurred for purposes other than creation of physical or financial assets of the central government.
• Relates to expenses incurred for the normal functioning of the government departments and various services, interest payments on debt incurred by the government, and grants given to state governments and other parties (even though some of the grants may be meant for creation of assets).

Capital Expenditure

• Expenditures of the government which result in the creation of physical or financial assets or reduction in financial liabilities.
• Includes expenditure on the acquisition of land, building, machinery and equipment, investment in shares, and loans and advances by the central government to state and union territory governments, PSUs and other parties.

Budgetary Deficit or Overall Deficit

• Excess of total estimated expenditure over total estimated revenue.
• The difference between all receipts and expenditure, both revenue and capital.

Revenue Deficit

• Excess of the government’s revenue expenditure over revenue receipts.
• Shows the shortfall of the government’s current receipts over current expenditure.
• Shows the government revenue is insufficient to meet the regular expenditures in connection with the normal functioning of the government, or the government is diverting resources from other sectors to finance its current expenditure.
• Revenue deficit = Revenue expenditure – Revenue receipts

Fiscal Deficit

• When the government’s non-borrowed receipts fall short of its entire expenditure, it has to borrow money from the public to meet the shortfall.
• The excess of total expenditure over total receipts excluding borrowings during a given fiscal year.
• The difference between the government’s total expenditure and its total receipts excluding borrowing.
• Often presented as a percentage of the gross domestic product (GDP).
• Total Receipts excluding borrowing = Revenue Receipts + Capital Receipts excluding borrowing or (Non debt creating capital receipts).
• Non-debt creating capital receipts include recoveries of loans advanced by the government and sale proceeds of government assets, including those realized from divestment of government equity in public sector undertakings (PSUs).
• Fiscal deficit = Total Expenditure –Total Receipts excluding borrowing
• Fiscal Deficit = (Revenue Expenditure + Capital Expenditure) – (Revenue Receipts + Capital Receipts excluding borrowing)
• Fiscal Deficit = (Revenue Expenditure- Revenue Receipts) + (Capital Expenditure – Capital Receipts excluding borrowing)
• Fiscal Deficit = Revenue Deficit + (Capital Expenditure - Capital Receipts excluding borrowing)
• The fiscal deficit will have to be financed by borrowing.
• Fiscal deficit points to the total borrowing requirements of the government from all sources.
• In case the revenue deficit occupies a substantial share of the fiscal deficit, it is an indication that a large part of borrowing is used for consumption purposes rather than for investment.

Primary Deficit

• Fiscal deficit of the current year minus interest payments on previous borrowings.
• Indicates borrowing requirement exclusive of interest payment.
• Tells how much of the government’s borrowings are going towards meeting expenses other than interest payments.
• Gives an estimate of borrowings on account of current expenditure exceeding current revenues.
• The goal of measuring the primary deficit is to focus on present fiscal imbalances.
• Primary deficit = Fiscal deficit – Net Interest liabilities
• Net interest liabilities = interest payments minus interest receipts by the government on domestic lending.

Finance Bill

• The Bill produced immediately after the presentation of the union budget detailing the Imposition, abolition, alteration, or regulation of taxes proposed in the budget.

Outcome Budget

• Establishes a direct link between budgetary allocations of schemes and its annual performance targets measured through output and outcome indicators.
• A progress card on what various ministries and departments have done with the outlays in the previous annual budget.
• Measures the development outcomes of all government programs and whether the money has been spent for the purpose it was sanctioned including the outcome of the fund usage.

Guillotine

• Once the prescribed period for the discussion on demands for grants is over, the speaker of Lok Sabha puts all the outstanding demands for grants, whether discussed or not, to the vote of the house.
• This process is popularly known as 'Guillotine'.

Cut Motions

• Motions for reduction to various demands for grants are made in the form of cut motions seeking to reduce the sums sought by the government on grounds of economy or difference of opinion on matters of policy or just in order to voice a grievance.

Consolidated Fund of India

• All revenues received, loans raised, and all moneys received by the government in repayment of loans are credited to the Consolidated Fund of India and all expenditures of the government are incurred from this fund.
• Money can be spent through this fund only if appropriated by the parliament.
• The consolidated Fund has further been divided into ‘revenue’ and ‘capital’ divisions.

Contingency Fund of India

• A fund placed at the disposal of the President to enable him/her to make advances to the executive/Government to meet urgent unforeseen expenditure.
• Enables the government to meet unforeseen expenditure and does not require prior legislative approval, unlike with the Consolidated Fund.
• For meeting such exigencies, advances are made to the executive from the contingency fund which is subsequently reported to the Parliament for recoupment from the Consolidated Fund of India.

Public Account

• Under provisions of Article 266(1) of the Constitution of India, the public account is used in relation to all the fund flows where the government is acting as a banker.
• Examples include Provident Funds and Small Savings.
• This money does not belong to the government but is to be returned to the depositors.
• The expenditure from this fund need not be approved by the parliament.