TOPIC: General Studies 3
- Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
- Government Budgeting.
Fiscal Policy Management
What is Fiscal Policy?
- Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation’s economy.
- It is that part of the government policy which is concerned with raising revenue through taxation and deciding on the amount and purpose of the government spending.
- It deals not only with the quantity of funds but also the quality of public finance.
What is Fiscal Deficit?
Fiscal Deficit is the difference between the government earnings and its spending. It is the difference between what is received by the government on revenue account and all the non debt creating capital receipts.
Fiscal Deficit = Total government expenditure – Revenue Receipts – Non Debt Creating Capital Receipts
What is Fiscal Consolidation?
Fiscal Consolidation refers to the strengthening of government finances. It helps the government to cut down on wasteful expenditure and enables it spend more on social sector and infrastructure.
Effective fiscal consolidation has allowed India to emerge as a preferred investment destination. This has been a result of strength of its policy and institutional frameworks.
Various measures and decisions that have contributed to fiscal consolidation in India are:
- E-auctioning of natural resources,
- a rule-based framework for Indian monetary policy,
- Insolvency and Bankruptcy code,
- Introduction of the Goods and Services Tax (GST),
Other aspects of conduct of fiscal policy which have played an important role in contributing towards improving India’s growth and investment potential include:
- Restraint on unproductive spending,
- Plugging of subsidy leakage through implementation of the Direct Benefits Transfer (DBT),
- Higher devolution of revenue to States and local self-governments,
- Greater autonomy to States for spending on developmental plans,
- Guidelines under the Fiscal Responsibility and Budget Management Act (FRBM).
What is FRBM Act?
- FRBM Act was first introduced in India in December 2000 to bring down the increasing government deficits both at the Centre and in the States.
- It was enacted in 2003 to institutionalise fiscal discipline, by seeking to eliminate revenue deficit and to bring down fiscal deficit to a manageable 3 per cent of GDP by Financial Year 2008-09.
Objectives of FRBM Act
- Fiscal discipline
- Increasing planned expenditure
- Reduction in amount of borrowings
- To meet the consumption from government’s own fiscal resources
- Give autonomy to Reserve Bank of India (RBI) for money creation
Reforms in FRBM Act
In the light of current domestic and global dynamics, a committee has been formed to review the FRBM Act. Certain changes which could be made in the FRBM Act considering the contemporary needs are as follows:
- Adoption of a ‘Point based’ and appropriate fiscal deficit target:
- A point based target infuses fiscal discipline.
- It limits the room for government trying too many things.
- It also provides an unambiguous signal to the bond markets.
- Such a target will lead to focused policy communication and subsequently help in ratings upgrade for India.
- A favourable economic atmosphere will lower the cost of borrowing for the private sector and aid new capital and investment formation.
- Rules serving as guiding principles:
- Effective rule-based policy would help the governments adopt a countercyclical approach and limit the scope for creative accounting which involves capitalizing on loopholes in the accounting standards to falsely portray a better image of the company.
- A ‘spending rule’ with a medium-term debt range and due consideration to institutional setting could enhance the policy credibility, allow effective monitoring and ensure stability, fairness and efficiency.
- A ‘debt sustainability rule’ can help in implementing a ceiling on government debt. This will also allow India to act as per the Maastricht Treaty guidelines.
- An ‘expenditure rule’ that focuses on improving the quantity and quality of spending and improve accountability could be chosen.
- Independent constitutional body as a watchdog:
- FRBM Act should provide for an independent reviewer or a Fiscal Council, to oversee the adoption of rule-based fiscal policy and also recommend future course of action.
- A well-designed fiscal council with strict operational independence will boost fiscal accountability and transparency and also contribute in enhancing the ratings of India.
Adoption of FRBM 2.0 framework will enhance the efficacy of India’s fiscal policy and significantly reduce the twin-deficit vulnerability. At a time when most developed economies are struggling with their government’s fiscal management efficiency, a rule-based system with room for independent advisory and oversight can transform India’s fiscal architecture and promote investment in India at a major scale.
Connecting the dots
- Define Fiscal Consolidation and steps in the recent past taken by the government to ensure fiscal consolidation. Suggest changes that can be made in the FRBM Act to increase its contribution to fiscal consolidation.
TOPIC: General Studies 2
- Government policies and interventions for development in various sectors and issues arising out of their design and implementation.
Fighting the corruption on six fronts
- The demonetisation move has affected all the people who have cash which is unaccounted for. However, this money will not be destroyed. Instead, it will be sold at a discount, and laundered in various ways.
- The person who has unaccounted cash will have to bear a substantial loss of 25-50%. Due to such consequences, the people who have resented corruption and criminality in high places are celebrating the move.
- On a flip side, the Indian’s money supply is largely based on cash and it is a critical medium of transactions. Thus, the demonetisation move has been a large contractionary monetary shock, which has had adverse implications for the business cycle.
The Black economy
There are three components of black economy
- Underlying source of corruption– for example, high stamp duties on real estate transactions that lead to payments in cash.
- Methods adopted for storing unaccounted wealth– for example- holding liquid assets in gold.
- Method through which transactions are affected– this involves the cash transactions
The people who resorted to black money have been penalised by 25-50% due to demonetisation. But, they will soon find ways to use the new currency illegally. Hence, now is the need for policy which sets higher vision to disrupt the black economy totally.
For this, the focus needs to be on the core of the corrupt activity. We shall look into details of six such areas which needs to be targeted.
- Before liberalisation, there was a booming industry of smuggling gold in India.
- In 1991, this was put to an end by eliminating restrictions against gold imports.
- For this, a great deal of work went into the establishment of a white-money gold and jewellery business. But this developmental work received a major setback in 2013, when the customs duty on gold was reintroduced.
- As a result, the buyer started making cash payment in order to have discount. Hence, this was a blow to the world of gold and jewellery that was being conducted through white money.
- So now, instead of targeting jewellers and their customers, the better idea would be to eliminate the customs duty.
- The Hawala is an alternative remittance channel that exists outside of traditional banking systems whereby the money is transferred without any actual movement of money.
- For example: Person A (Dubai) wants to send 1 lakh riyal to person B (India). Person A will contact Hawala agent X and tell him to transfer the money to person B. Agent X will contact Hawala agent Y in India and ask him to give Indian rupee equivalent to 1 lakh riyal. Person B will contact Agent Y and take money. Agent X and Agent Y will settle their accounts later and once done, they will destroy all evidence of transaction.
- The hawala business came up in the 1960s and 1970s due to capital controls that were a part of Indian socialism. Hawala transactions avoid tax, has low commission rates than banks and is fast and convenient to send illegal money.
- Capital control= residency-based measures such as transaction taxes, other limits, or outright prohibitions that a nation’s government can use to regulate flows from capital markets into and out of the country’s capital account.
- Indian businessmen and citizens have a robust history of business activities in East Africa, West Asia and South-East Asia. But the cross-border activities are mired in complicated regulations. Recent spat between Tata and Docomo is an example of problems created due to India’s capital control.
- Thus, instead of policing against people involved in hawala transaction, India should look forward to become a ‘most open economy in world’ as envisaged by PM and also improve its ranking in Chinn-Ito index (measures capital-account restrictions) where it is currently placed at the bottom of the table.
- Real estate sector is widely mired in black money transaction where the secondary market generally involves a cash component.
- Cash payment is favoured so as to avoid stamp duty. Just like custom duty, stamp duty also attracts tax evasion and thus, more generation of black money. Instead real estate can have GST.
- At present, buying land and settling disputes often involves criminality, as there are title disputes.
- Hence, Building sound land-title systems will enable law-abiding citizens to buy and sell land without a brush with cash or criminality through equity market which has shown how to build infrastructure for tracking property rights and achieving frictionless transactions.
- The tax administration in India has limited capabilities and hence, tax policy must put a low “load” upon the tax administration by favouring simplicity and low rates.
- Under, the present levels of state capacity, the high interest rates and complex code has led to corruption in economy.
- A GST has a single rate will eliminate classifying a given product at a high rate or a low rate. And the low rates will push both the tax administrator and the citizen in favour of compliance.
- For this, a new tax administration act is required which sets up the Central board of direct taxes and Central board of excise and customs with sound processes for their legislative, executive and quasi-judicial functions.
- Arbitrary power is the root cause of corruption. The government has the discretion to change a rule, give a licence, conduct an investigation etc. and such actions should be covered by procedural law, which enshrines good governance.
- When a coal mine has to be allocated, there has to be a structured process for it, before any punishment is pronounced, the accused must be given a statement of the accusation and the evidence in writing. These are basic rules to be followed, yet it is presently lacking in many parts of the Indian state.
- The regulators need to be established with proper statutes as they have legislative power (the power to write law, i.e. regulations), executive power (the power to give licences, the power to conduct investigation) and quasi-judicial power (the power to award punishment).
- Thus, such an administrative environment should be balanced in order to prevent hegemony of few.
Politics and elections
- Running a political party and fighting elections requires large-scale resourcing.
- The complex procedures force the political parties to engage in these activities using black money. During elections, the arbitral and unpractical spending and donation limits encourage political parties to find alternate ways of funding.
- Thus, there is a need for fundamental reforms are required so that funding in white money is made possible.
- This will also allow the Indian political system to go beyond family-dominated political parties.
Thus, to truly disrupt the shadow economy, fundamental reforms targeting these areas is a must.
Connecting the dots:
- Knowing and targeting the source of black money is important than making efforts to clean it up from top. Identify the possible sources and state ways to clean up the core.