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Sunday, December 11, 2011


What is Finance? Meaning

Before we begin, first let’s understand the origin of word “FINANCE.”
If we trace the origin of finance, there is evidence to prove that it is as old as human life on earth. The word finance was originally a French word. In the 18th century, it was adapted by English speaking communities to mean “the management of money.” Since then, it has found a permanent place in the English dictionary. Today, finance is not merely a word else has emerged into an academic discipline of greater significance. Finance is now organized as a branch of Economics.

Furthermore, the one word which can easily replace finance is “EXCHANGE." Finance is nothing but an exchange of available resources. Finance is not restricted only to the exchange and/or management of money. A barter trading system is also a type of finance. Thus, we can say, Finance is an art of managing various available resources like money, assets, investments, securities, etc.
At present, we cannot imagine a world without Finance. In other words, Finance is the soul of our economic activities. To perform any economic activity, we need certain resources, which are to be pooled in terms of money (i.e. in the form of currency notes, other valuables, etc.). Finance is a prerequisite for obtaining physical resources, which are needed to perform productive activities and carrying business operations such as sales, pay compensations, reserve for contingencies (unascertained liabilities) and so on.
Hence, Finance has now become an organic function and inseparable part of our day-to-day lives. Today, it has become a word which we often encounter on our daily basis.

Definition of Finance

Finance is defined in numerous ways by different groups of people. Though it is difficult to give a perfect definition of Finance following selected statements will help you deduce its broad meaning.
1. In General sense,
"Finance is the management of money and other valuables, which can be easily converted into cash."
2. According to Experts,
"Finance is a simple task of providing the necessary funds (money) required by the business of entities like companies, firms, individuals and others on the terms that are most favourable to achieve their economic objectives."
3. According to Entrepreneurs,
"Finance is concerned with cash. It is so, since, every business transaction involves cash directly or indirectly."
4. According to Academicians,
"Finance is the procurement (to get, obtain) of funds and effective (properly planned) utilisation of funds. It also deals with profits that adequately compensate for the cost and risks borne by the business."

Features of Finance

The main characteristics or features of finance are depicted below.


1. Investment Opportunities

In Finance, Investment can be explained as a utilisation of money for profit or returns.
Investment can be done by:-
  1. Creating physical assets with the money (such as development of land, acquiring commercial assets, etc.),
  2. Carrying on business activities (like manufacturing, trading, etc.), and
  3. Acquiring financial securities (such as shares, bonds, units of mutual funds, etc.).
Investment opportunities are commitments of monetary resources at different times with an expectation of economic returns in the future.

2. Profitable Opportunities

In Finance, Profitable opportunities are considered as an important aspiration (goal).
Profitable opportunities signify that the firm must utilize its available resources most efficiently under the conditions of cut-throat competitive markets.
Profitable opportunities shall be a vision. It shall not result in short-term profits at the expense of long-term gains.
For example, business carried on with non-compliance of law, unethical ways of acquiring the business, etc., usually may result in huge short-term profits but may also hinder the smooth possibility of long-term gains and survival of business in the future.

3. Optimal Mix of Funds

Finance is concerned with the best optimal mix of funds in order to obtain the desired and determined results respectively.
Primarily, funds are of two types, namely,
  1. Owned funds (Promoter Contribution, Equity shares, etc.), and
  2. Borrowed funds (Bank Loan, Bank overdraft, Debentures, etc).
The composition of funds should be such that it shall not result in loss of profits to the Entrepreneurs (Promoters) and must recover the cost of business units effectively and efficiently.

4. System of Internal Controls

Finance is concerned with internal controls maintained in the organisation or workplace.
Internal controls are set of rules and regulations framed at the inception stage of the organisation, and they are altered as per the requirement of its business.
However, these rules and regulations are monitored at various intervals to accomplish the same which have been consistently followed.

5. Future Decision Making

Finance is concerned with the future decision of the organisation.
A "Good Finance” is an indicator of growth and good returns. This is possible only with the good analytical decision of the organisation. However, the decision shall be framed by giving more emphasis on the present and future perspective (economic conditions) respectively.

Conclusion on Finance

Finance to be more precise is concerned with the management of,
  1. Owned funds (promoter contribution),
  2. Raised funds (equity share, preference share, etc.), and
  3. Borrowed funds (loans, debentures, overdrafts, etc.).
At the same time, Finance also encompasses wider perspective of managing the business generated assets and other valuables more efficiently.
Meaning of Fiscal Policy ↓

The fiscal policy is concerned with the raising of government revenue and incurring of government expenditure. To generate revenue and to incur expenditure, the government frames a policy called budgetary policy or fiscal policy. So, the fiscal policy is concerned with government expenditure and government revenue.

Fiscal policy has to decide on the size and pattern of flow of expenditure from the government to the economy and from the economy back to the government. So, in broad term fiscal policy refers to "that segment of national economic policy which is primarily concerned with the receipts and expenditure of central government." In other words, fiscal policy refers to the policy of the government with regard to taxation, public expenditure and public borrowings.
The importance of fiscal policy is high in underdeveloped countries. The state has to play active and important role. In a democratic society direct methods are not approved. So, the government has to depend on indirect methods of regulations. In this way, fiscal policy is a powerful weapon in the hands of government by means of which it can achieve the objectives of development.

Main Objectives of Fiscal Policy In India ↓

The fiscal policy is designed to achive certain objectives as follows :-

1. Development by effective Mobilisation of Resources

The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by Mobilisation of Financial Resources.
The central and the state governments in India have used fiscal policy to mobilise resources.
The financial resources can be mobilised by :-
  1. Taxation : Through effective fiscal policies, the government aims to mobilise resources by way of direct taxes as well as indirect taxes because most important source of resource mobilisation in India is taxation.
  2. Public Savings : The resources can be mobilised through public savings by reducing government expenditure and increasing surpluses of public sector enterprises.
  3. Private Savings : Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilised through government borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic and foreign parties and by deficit financing.
2. Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources. These resources are allocated for Development Activities which includes expenditure on railways, infrastructure, etc. While Non-development Activities includes expenditure on defence, interest payments, subsidies, etc.
But generally the fiscal policy should ensure that the resources are allocated for generation of goods and services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to encourage production of desirable goods and discourage those goods which are socially undesirable.

3. Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society. The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to improve the conditions of poor people in society.

4. Price Stability and Control of Inflation

One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by Reducing fiscal deficits, introducing tax savings schemes, Productive use of financial resources, etc.

5. Employment Generation

The government is making every possible effort to increase employment in the country through effective fiscal measure. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generates more employment. Various rural employment programmes have been undertaken by the Government of India to solve problems in rural areas. Similarly, self employment scheme is taken to provide employment to technically qualified persons in the urban areas.

6. Balanced Regional Development

Another main objective of the fiscal policy is to bring about a balanced regional development. There are various incentives from the government for setting up projects in backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.

7. Reducing the Deficit in the Balance of Payment

Fiscal policy attempts to encourage more exports by way of fiscal measures like Exemption of income tax on export earnings, Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc.
The foreign exchange is also conserved by Providing fiscal benefits to import substitute industries, Imposing customs duties on imports, etc.
The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem. In this way adverse balance of payment can be corrected either by imposing duties on imports or by giving subsidies to export.

8. Capital Formation

The objective of fiscal policy in India is also to increase the rate of capital formation so as to accelerate the rate of economic growth. An underdeveloped country is trapped in vicious (danger) circle of poverty mainly on account of capital deficiency. In order to increase the rate of capital formation, the fiscal policy must be efficiently designed to encourage savings and discourage and reduce spending.

9. Increasing National Income

The fiscal policy aims to increase the national income of a country. This is because fiscal policy facilitates the capital formation. This results in economic growth, which in turn increases the GDP, per capita income and national income of the country.

10. Development of Infrastructure

Government has placed emphasis on the infrastructure development for the purpose of achieving economic growth. The fiscal policy measure such as taxation generates revenue to the government. A part of the government's revenue is invested in the infrastructure development. Due to this, all sectors of the economy get a boost.

11. Foreign Exchange Earnings

Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange provides fiscal benefits to import substitute industries. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem.

Conclusion On Fiscal Policy ↓

The objectives of fiscal policy such as economic development, price stability, social justice, etc. can be achieved only if the tools of policy like Public Expenditure, Taxation, Borrowing and deficit financing are effectively used.
Though there are gaps in India's fiscal policy, there is also an urgent need for making India's fiscal policy a rationalised and growth oriented one.
The success of fiscal policy depends upon taking timely measures and their effective administration during implementation.
Measures To Overcome Fiscal Imbalance In India ↓

Fiscal imbalance takes place due to excess of government expenditure over revenue. To overcome the deficit, government resort to borrowings. This further aggravates the situation of debt servicing.
Therefore there is a need to correct and overcome the fiscal imbalance.

The fiscal imbalance can be corrected by adopting following two methods:-
  1. Reducing Government Expenditure.
  2. Raising proper financial resources (funds) for productive purposes.
A. Reduce Government Expenditure ↓

Suggested ways by which government's expenditure can be reduced are :-

1. Reduction in Interest Burden

Over the years, there has been considerable increase in Government borrowings. As a result, the interest payment of the Government has increased considerably. The interest payment has been the single major component of revenue expenditure of both the state and central government. For instance, the interest payment of the central government of India has increased from Rs.21,500 crores in 1990-91 to Rs.1,39,823 crores in 2005-06, which works out as 33% of the total revenue expenditure. Therefore, there is a need to reduce government borrowings so as to reduce interest burden, which in turn would reduce Government expenditure.

2. Reducing Subsidies

The government of India has been providing subsidies on a number of items such as food, fertilizers, education, interest to priority section, and so on. Because of the massive amounts of subsidies, the government expenditure has increased over the years. Therefore there is need to reduce government subsidies.

3. Reduction in Government Overheads

The public sectors and government departments are subject to high overheads. There is often overstaffing due to poor manpower planning. Also, there are huge overheads in respect of maintenance of machines, consumption of energy, and so on. Some of the overheads can be easily reduced. Therefore, there is a need to reduce overheads, wherever possible, in order to reduce Government expenditure.

4. Closure of Sick Units

The government needs to close down the sick public sectors or disinvest them. Closing down non-viable sick units would enable the government to save their valuable resources which otherwise would have been used for such sick units. Disinvestment would generate additional revenue to the government. In India, the disinvestment process was started in 1991-92. However, the process of disinvestment is very slow in India due to political compulsion.

B. Raise Government Funds ↓

Suggested ways by which government's funds can be raised are :-

1. Collection of user charges

The government should take adequate measures to collect user charges from the consumer in respect of public utilities like water supply, electricity, irrigation, transport, etc. The user charges are subsidized in case of certain services.

2. Improvement in Performance of PSUs

Due to poor performance of PSUs, the government loses a good amount of revenue by way of dividends. Therefore, the government should make every effort to improve efficiency and performance of public sector units (PSUs), which in turn would enable the government to obtain more funds for productive expenditure.

3. Proper Mobilization of Tax Resources

In India there is a good deal of tax evasion both of direct and indirect taxes.
The tax evasion is due to the following reasons :-
  1. High tax rates,
  2. Too many formalities and documentation work,
  3. Inefficient and corrupt tax administration.
Therefore, the government should make proper efforts to simplify the tax procedures, and at the same time take appropriate measures to reduce tax evasion.

4. Market oriented development

Market oriented development will stimulate demand and encourage growth. Incentives are given through the fiscal policy to encourage the private sector investments. The areas of operation of public sector enterprises have been reduced. This will reduce governments borrowing and its dependence on household savings.

New Fiscal Policy of India ↓

In view of the economic liberalization in the recent years, certain themes have been emphasized in the New Fiscal Policy of India. They are :-
  1. Simplification of tax structure and laws.
  2. Reasonable direct taxes and better administration.
  3. Stable tax policy environment.
  4. Weightage to resource allocation and equity consequences of taxation.
  5. More reliance on fiscal and financial instrument in managing the economy.
  6. Better links between fiscal and monetary policy.
  7. Strengthening methods of expenditure control.
Final Conclusion ↓
The Fiscal measures adopted by the Govt of India would reduce the inflation, reduce the deficit in balance of payments and promote growth and unemployment. The effects of the new fiscal policy are likely to be favourable to the indian economy.

Reforms in the Indian Monetary Policy During 1990s

The Monetary policy of the RBI has undergone massive changes during the economic reform period. After 1991 the Monetary policy is disassociated from the fiscal policy. Under the reform period an emphasis was given to the stable macro economic situation and low inflation policy.

The major changes in the Indian Monetary policy during the decade of 1990.
  1. Reduced Reserve Requirements : During 1990s both the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) were reduced to considerable extent. The CRR was at its highest 15% plus and additional CRR of 10% was levied, however it is now reduced by 4%. The SLR is reduced form 38.5% to a minimum of 25%.
  2. Increased Micro Finance : In order to strengthen the rural finance the RBI has focused more on the Self Help Group (SHG). It comprises small and marginal farmers, agriculture and non-agriculture labour, artisans and rural sections of the society. However still only 30% of the target population has been benefited.
  3. Fiscal Monetary Separation : In 1994, the Government and the RBI signed an agreement through which the RBI has stopped financing the deficit in the government budget. Thus it has seperated the Monetary policy from the fiscal policy.
  4. Changed Interest Rate Structure : During the 1990s, the interest rate structure was changed from its earlier administrated rates to the market oriented or liberal rate of interest. Interest rate slabs are now reduced up to 2 and minimum lending rates are abolished. Similarly, lending rates above Rs. Two lakh are freed.
  5. Changes in Accordance to the External Reforms : During the 1990, the external sector has undergone major changes. It comprises lifting various controls on imports, reduced tariffs, etc. The Monetary policy has shown the impact of liberal inflow of the foreign capital and its implication on domestic money supply.
  6. Higher Market Orientation for Banking : The banking sector got more autonomy and operational flexibility. More freedom to banks for methods of assessing working funds and other functioning has empowered and assured market orientation.

Evaluation of the Monetary Policy in India

During the reforms though the Monetary policy has achieved higher success in the Monetary policy, it is not free from limitation or demerits. It needs to be evaluated on a proper scale.
  1. Failed in Tackling Budgetary Deficit : The higher level of the budget deficit has made the Monetary policy ineffective. The automatic monetization of the deficit has led to high Monetary expansion.
  2. Limited Coverage : The Monetary policy covers only commercial banking system leaving other non-bank institutions untouched. It limits the effectiveness of the monitor policy in India.
  3. Unorganized Money Market : In our country there is a huge size of the unorganized money market. It dose not come under the control of the RBI. Thus any tools of the Monetary policy dose not affect the unorganized money market making Monetary policy less affective.
  4. Predominance of Cash Transaction : In India still there is huge dominance of the cash in total money supply. It is one of the main obstacles in the effective implementation of the Monetary policy. Because Monetary policy operates on the bank credit rather on cash.
  5. Increase Volatility : As the Monetary policy has adopted changes in accordance to the changes in the external sector in India, it could lead to a high amount of the volatility.
There are certain drawbacks in the working of the Monetary Policy in India. However, during the economic reforms it has got different dimensions.

What is Fiscal Crisis ?

The fiscal imbalance takes place when the government expenditure exceeds government revenue. This fiscal imbalance is also refered as the fiscal crisisIn 1980, the growing burden of non-development expenditure caused deterioration in the fiscal situation of India. Later this resulted in a fiscal crisis at the beginning of 1991-1992.
Indicators of Fiscal Crisis ↓

The main indicators of fiscal crisis are various deficits such as :-
  1. Revenue Deficit (RD) : It is the difference between revenue receipts (income) and revenue expenditure.
  2. Budgetary Deficit (BD) : It is the difference between total expenditure and total receipts. Here, both revenue and capital expenditure and receipts are considered.
  3. Fiscal Deficit (FD) : It is the excess of total expenditure over revenue receipts and grants. In other words, fiscal deficit is the budget deficit plus government borrowings and other liabilities.
  4. Primary Deficit (PD) : It is the fiscal deficit minus interest payments.
5.   Causes of Fiscal Crisis ↓
6.       
7.      The main factors responsible for the fiscal crisis in India are as follows :-
8.       
9.   1. Increase in Subsidies
10.   
11.  The government has been providing subsidies on a number of items such as fertilizers, exports, food items, etc. This has resulted in a fiscal imbalance. The major subsidies provided by the Central Government of India has increased over the years resulting in fiscal imbalance.

2. Payment of Interest

One of the major components of government expenditure is the interest payment both on domestic loans and foreign loans. The government debt has increased considerably over the years. This has resulted in increased interest burden on the government.
Interest payment of the Central Government increased from Rs. 21,500 crores in 1990-91 to Rs. 1,39,823 crores in 2006-07.

3. Defence Expenditure

The defence expenditure is increasing over the years. The government has limited scope to reduce defence budget due to security problems across the Indian borders. The defence expenditure on the part of central government has increased from Rs. 10,874 crores in 1990-91 to Rs. 51,542 crores in 2006-07.

4. Poor Performance of Public Sector

The poor performance of public sector has also resulted in fiscal imbalance. The poor performance of public sector is due to various reasons such as political interference, inefficiency and corruption of management, low labour efficiency, lack of professionalism, surplus staff, etc.
Due to poor performance of public sector, the Government gets low revenue by way of dividend from public sector units.

5. Excessive Government borrowings

The internal and external debt of the government has increased considerably during the past few decades. Due to the debts; the government has to incur high expenditure in form of interest payments.

6. Tax Evasion

Indian tax system is made up of complex procedures with numerous exemptions. Corruptions is rampant at all levels, which leads to the fiscal imbalance.

7. Weak Revenue Mobilisation

While increase in government expenditure has been the major cause of fiscal imbalance, inadequate rise in revenue receipts also contributed to fiscal imbalance. The revenue receipts of the centre, consisting of tax revenue, net of state's share and non-tax revenue, has increased at slower rate than that of growth in expenditure.

8. Huge Borrowings

The gap between expenditure and revenue is financed through loans, both internal and external. The borrowings have been spent on unproductive purposes as well. The huge borrowings resulted in large interest payments.

9. Other Causes

Unproductive expenditure by the government, Weak resource mobilisation and Low Capital Formation.
Consequences of Fiscal Crisis ↓

The fiscal imbalance has resulted in harmful consequences like mounting inflation, deficit in balance of payment, etc. It has also adversely affected the growth of economy. The government must introduce major fiscal correction policies to overcome the fiscal crisis.
The consequences of fiscal crisis i.e. a sustained high fiscal deficits over 20 years are as follows :-

1. Debt Trap

With increasing levels of borrowing for financing activities, which have zero or low yields, interest payments increase at faster rate. Thus, non-productive expenditures rise, give rise to higher and higher revenue deficits.

2. Cut in Capital Expenditure

Because of debt service payments forming a higher proportion of expenditures, all other activities of the government suffer. The main sufferer in this process is government capital expenditure in both economic and social infrastructure.

3. No Increase in Expendture on Education and Health

High debt service payments also prevents increase in or even maintenance of real expenditure on social services, i.e. on education and public health.

4. High Interest Rates

The continued high level of public borrowings has an effect on the rest of the economy through prevalence of high interest rates.

5. Slow Economic Growth

The fiscal imbalance affects economic growth in the country. Fiscal imbalance first affects capital formation which in turn affects the economic growth.

6. Other Consequences

Some other consequences of fiscal crisis are :-
  1. Fiscal imbalance may also lead to inflation in the economy.
  2. High fiscal deficit may discourage foreign investment in the country.
  3. The government has to borrow additional funds to solve fiscal deficit, which put extra burden on the government for payment of interest. It further worsens the fiscal imbalance.
Conclusion On Fiscal Crisis ↓

The fiscal imbalance however still continue as the Government has failed to reduce its own expenditure. The extravagant expenditure done by politicians and minister continues without any restriction. The populist policy followed by the Government, failure to reduce fertilizer subsidy, and massive burden of interest payment has still not take out the Indian economy from a situation of severe fiscal imbalances.
What is a Budget Deficit ? Meaning ↓

When the government expenditure exceeds revenues, the government is having a budget deficit. Thus the budget deficit is the excess of government expenditures over government receipts (income). When the government is running a deficit, it is spending more than it's receipts.


What is Budget Deficit ? Types of Budgetary Deficit - India Trends


What is a Budget Deficit ? Meaning ↓


When the government expenditure exceeds revenues, the government is having a budget deficit. Thus the budget deficit is the excess of government expenditures over government receipts (income). When the government is running a deficit, it is spending more than it's receipts.



The government finances its deficit mainly by borrowing from the public, through selling bonds, it is also financed by borrowing from the Central Bank.

Types of Budgetary Deficit ↓


The different types of budgetary deficit are explained in following points :-

1. Revenue Deficit


Revenue Deficit takes place when the revenue expenditure is more than revenue receipts. The revenue receipts come from direct & indirect taxes and also by way of non-tax revenue.
The revenue expenditure takes place on account of administrative expenses, interest payment, defence expenditure & subsidies.
Table below indicate revenue deficit of the central government of India.


From the above table it is clear that revenue deficit was Rs. 18,562 crores in 1990-91 and Rs. 94,644 crores in 2005-06. As proportion of GDP, revenue deficit increased from 1.5% in 1980-81 to 3.3% in 1990-91 and declined to 2.7% in 2005-06. The decline is due to the passing of the Fiscal Responsibility and Budget Management Act in 2002.

2. Budgetary Deficit


Budgetary Deficit is the difference between all receipts and expenditure of the government, both revenue and capital. This difference is met by the net addition of the treasury bills issued by the RBI and drawing down of cash balances kept with the RBI. The budgetary deficit was called deficit financing by the government of India. This deficit adds to money supply in the economy and, therefore, it can be a major cause of inflationary rise in prices.
Budgetary Deficit of central government of India was Rs. 2,576 crores in 1980-81, it went up to Rs. 11,347 crores in 1990-91 to Rs. 13,184 crores in 1996-97.
The concept of budgetary deficit has lost its significance after the presentation of the 1997-98 Budget. In this budget, the practice of ad hoc treasury bills as source of finance for government was discontinued. Ad hoc treasury bills are issued by the government and held only by the RBI. They carry a low rate of interest and fund monetized deficit. These bills were replaced by ways and means advance. Budgetary deficit has not figured in union budgets since 1997-98. Since 1997-98, instead of budgetary deficit, Gross Fiscal Deficit (GFD) became the key indicator.

3. Fiscal Deficit


Fiscal Deficit is a difference between total expenditure (both revenue and capital) and revenue receipts plus certain non-debt capital receipts like recovery of loans, proceeds from disinvestment.
In other words, fiscal deficit is equal to budgetary deficit plus governments market borrowings and liabilities. This concept fully reflects the indebtedness of the government and throws light on the extent to which the government has gone beyond its means and the ways in which it has done so. in 1980-81, fiscal deficit was Rs. 7,733 crores. Between 1980-81 and 1990-91 it increased 5 times to Rs. 37,606 crores. Since the introduction of economic reforms in 1991-92, the government has tried to restrict the growth of fiscal deficit. As percentage of GDP fiscal deficit declined from 6.2% in 2001-02 to 4.1% in 2005-06.

4. Primary Deficit


The fiscal deficit may be decomposed into primary deficit and interest payment. The primary deficit is obtained by deducting interest payments from the fiscal deficit. Thus, primary deficit is equal to fiscal deficit less interest payments. It indicates the real position of the government finances as it excludes the interest burden of the loans taken in the past.
Table below indicate primary deficit as a Percentage of GDP.


Primary deficit of the central governent of India was 16,108 crores in 1990-91, it reduced to 14,591 crores in 2005-06.

5. Monetised Deficit


Monetised Deficit is the sum of the net increase in holdings of treasury bills of the RBI and its contributions to the market borrowing of the government. It shows the increase in net RBI credit to the government. It creates equivalent increase in high powered money or reserve money in the economy.

Conclusion ↓


All these budgetary deficit reveal fiscal imbalance. Fiscal imbalance & budget deficit result in harmful consequences like mounting inflation, deficit in balance of payment, etc. It has also adversely affect the growth of the economy. The government must introduce fiscal correction policies to overcome the deficit budget and fiscal crisis.


The government finances its deficit mainly by borrowing from the public, through selling bonds, it is also financed by borrowing from the Central Bank.

Types of Budgetary Deficit ↓

The different types of budgetary deficit are explained in following points :-

1. Revenue Deficit

Revenue Deficit takes place when the revenue expenditure is more than revenue receipts. The revenue receipts come from direct & indirect taxes and also by way of non-tax revenue.
The revenue expenditure takes place on account of administrative expenses, interest payment, defence expenditure & subsidies.
Table below indicate revenue deficit of the central government of India.

From the above table it is clear that revenue deficit was Rs. 18,562 crores in 1990-91 and Rs. 94,644 crores in 2005-06. As proportion of GDP, revenue deficit increased from 1.5% in 1980-81 to 3.3% in 1990-91 and declined to 2.7% in 2005-06. The decline is due to the passing of the Fiscal Responsibility and Budget Management Act in 2002.
What is a Budget ? Meaning and Concept

Government has several policies to implement in the overall task of performing its functions to meet the objectives of social & economic growth. For implementing these policies, it has to spend huge amount of funds on defence, administration, and development, welfare projects & various other relief operations. It is therefore necessary to find out all possible sources of getting funds so that sufficient revenue can be generated to meet the mounting expenditure.

Planning process of assessing revenue & expenditure is termed as Budget.
The term budget is derived from the French word "Budgette" which means a "leather bag" or a "wallet". It is a statement of the financial plan of the government. It shows the income & expenditure of the government during a financial year, which runs generally from 1stApril to 31st March.
Budget is most important information document of the government. One part of the government's budget is similar to company's annual report. This part presents the overall picture of the financial performance of the government. The second part of the budget presents government's financial plans for the period upto its next budget.
So, every citizen of a nation from the common man to the politician is eager to know about the budget as they would like to get an idea of the :-
  1. Financial performance of the government over the past one year.
  2. To know about the financial programmes & policies of the government for the next one year.
  3. To know how their standard of living will be affected by the financial policies of the government in the next one year.
Definitions of Budget

According to Tayler, "Budget is a financial plan of government for a definite period".
According to Rene Stourm, "A budget is a document containing a preliminary approved plan of public revenues and expenditure".

Components of Government Budget

The main components or parts of government budget are explained below.

1. Revenue Budget

This financial statement includes the revenue receipts of the government i.e. revenue collected by way of taxes & other receipts. It also contains the items of expenditure met from such revenue.

(a) Revenue Receipts ↓

These are the incomes which are received by the government from all sources in its ordinary course of governance. These receipts do not create a liability or lead to a reduction in assets.
Revenue receipts are further classified as tax revenue and non-tax revenue.

i. Tax Revenue :-
Tax revenue consists of the income received from different taxes and other duties levied by the government. It is a major source of public revenue. Every citizen, by law is bound to pay them and non-payment is punishable.
Taxes are of two types, viz., Direct Taxes and Indirect Taxes.
Direct taxes are those taxes which have to be paid by the person on whom they are levied. Its burden can not be shifted to some one else. E.g. Income tax, property tax, corporation tax, estate duty, etc. are direct taxes. There is no direct benefit to the tax payer.
Indirect taxes are those taxes which are levied on commodities and services and affect the income of a person through their consumption expenditure. Here the burden can be shifted to some other person. E.g. Custom duties, sales tax, services tax, excise duties, etc. are indirect taxes.

ii. Non-Tax Revenue :-
Apart from taxes, governments also receive revenue from other non-tax sources.
The non-tax sources of public revenue are as follows :-
  1. Fees : The government provides variety of services for which fees have to be paid. E.g. fees paid for registration of property, births, deaths, etc.
  2. Fines and penalties : Fines and penalties are imposed by the government for not following (violating) the rules and regulations.
  3. Profits from public sector enterprises : Many enterprises are owned and managed by the government. The profits receives from them is an important source of non-tax revenue. For example in India, the Indian Railways, Oil and Natural Gas Commission, Air India, Indian Airlines, etc. are owned by the Government of India. The profit generated by them is a source of revenue to the government.
  4. Gifts and grants : Gifts and grants are received by the government when there are natural calamities like earthquake, floods, famines, etc. Citizens of the country, foreign governments and international organisations like the UNICEF, UNESCO, etc. donate during times of natural calamities.
  5. Special assessment duty : It is a type of levy imposed by the government on the people for getting some special benefit. For example, in a particular locality, if roads are improved, property prices will rise. The Property owners in that locality will benefit due to the appreciation in the value of property. Therefore the government imposes a levy on them which is known as special assessment duties.
iii. India's Revenue Receipts :-
The tax revenue provides major share of revenue receipts to the central government of India. In 2006-07 tax revenue (direct + indirect taxes) of central government was Rs. 3,27,205 crores while non-tax revenue was Rs. 76,260 crores.

(b) Revenue Expenditure ↓

i. What is Revenue Expenditure ?
Revenue expenditure is the expenditure incurred for the routine, usual and normal day to day running of government departments and provision of various services to citizens. It includes both development and non-development expenditure of the Central government. Usually expenditures that do not result in the creations of assets are considered revenue expenditure.

ii. Expenses included in Revenue Expenditure :-
In general revenue expenditure includes following :-
  1. Expenditure by the government on consumption of goods and services.
  2. Expenditure on agricultural and industrial development, scientific research, education, health and social services.
  3. Expenditure on defence and civil administration.
  4. Expenditure on exports and external affairs.
  5. Grants given to State governments even if some of them may be used for creation of assets.
  6. Payment of interest on loans taken in the previous year.
  7. Expenditure on subsidies.
iii. India's Defence Expenditure :-
In 2006-07, Defence expenditure of the central government of India was Rs. 51,542 crores.

2. Capital Budget

This part of the budget includes receipts & expenditure on capital account projected for the next financial year. Capital budget consists of capital receipts & Capital expenditure.

(a) Capital Receipts ↓

i. What are Capital Receipts ?
Receipts which create a liability or result in a reduction in assets are called capital receipts. They are obtained by the government by raising funds through borrowings, recovery of loans and disposing of assets.

ii. Items included in Capital Receipts :-
The main items of Capital receipts (income) are :-
  1. Loans raised by the government from the public through the sale of bonds and securities. They are called market loans.
  2. Borrowings by government from RBI and other financial institutions through the sale of Treasury bills.
  3. Loans and aids received from foreign countries and other international Organisations like International Monetary Fund (IMF), World Bank, etc.
  4. Receipts from small saving schemes like the National saving scheme, Provident fund, etc.
  5. Recoveries of loans granted to state and union territory governments and other parties.
(b) Capital Expenditure ↓

i. What is Capital Expenditure ? :-
Any projected expenditure which is incurred for creating asset with a long life is capital expenditure. Thus, expenditure on land, machines, equipment, irrigation projects, oil exploration and expenditure by way of investment in long term physical or financial assets are capital expenditure.

Conclusion On Budget

Thus, we see that the budget mirrors projected receipts and expenditures.

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