Best Fiscal Policy Notes for Competitive Exams

Fiscal policy refers to the use of government spending, taxation, and borrowing to influence the economy. It is one of the two main tools of macroeconomic policy, the other being monetary policy. Fiscal policy can be used to stimulate or slow down economic growth, stabilize prices, and reduce unemployment. When the economy is in a recession or experiencing slow growth, the government can use expansionary fiscal policy, which involves increasing government spending, reducing taxes, or both.

Fiscal Policy

Fiscal Policy is the policy relating to public revenue and public expenditure and allied matters. Government spending policies that influence macroeconomic conditions. These policies affect tax rates, interest rates and government spending, in an effort to control the economy.

Revenue Account and Revenue Expenditure

A revenue Account refers to a financial statement that shows the revenue earned and expenses incurred by a business or organization over a specific period of time. It includes all the income generated from the sale of goods or services, as well as any other operating income, such as interest earned on investments or rental income. On the expense side, it includes all the costs of running the business, such as salaries and wages, rent, utilities, and other operating expenses.

Revenue Expenditure, on the other hand, refers to the expenses incurred by a business or organization that are not related to the purchase or acquisition of capital assets. It includes all the expenses incurred for the day-to-day running of the business, such as salaries and wages, rent, utilities, and other operating expenses.

Deficits

Deficits in fiscal policy occur when a government spends more money than it collects in revenue. This can happen due to various reasons, such as infrastructure projects, social programs, or economic stimulus. However, sustained deficits can lead to negative consequences like inflation, higher government debt, and reduced investor confidence. To manage deficits, governments may implement policies like raising taxes, reducing spending, or increasing economic growth.

Revenue Deficit

A revenue deficit is a situation that occurs when a government’s total revenue falls short of its total expenses, excluding capital expenditures such as infrastructure investments. In other words, it represents the excess of current expenditure over current revenue. Revenue deficits occur when a government’s regular income, such as tax revenue, grants, and other forms of revenue, is insufficient to meet its ongoing expenses such as salaries, subsidies, and interest payments. This can lead to the accumulation of debt and other long-term financial problems for the government.

Effective Revenue Deficit (ERD)

Effective Revenue Deficit (ERD) is a term used in economics and public finance to describe the gap between a government’s revenue expenditure and its revenue receipts. It is a measure of the deficit incurred by a government in its day-to-day operations, excluding capital expenditures. ERD represents the amount of money that a government spends on revenue-generating activities, such as social welfare schemes, subsidies, and salaries, which are not financed by its own revenue sources but instead are funded by borrowing or using capital receipts. ERD is considered a critical parameter of fiscal health because it highlights the extent to which a government is relying on borrowings to meet its revenue expenditures. The higher the ERD, the greater the proportion of government expenditure being funded through borrowing, which can lead to a significant burden of debt.

Fiscal Deficit

Fiscal deficit refers to the difference between a government’s total expenditure and its total revenue (excluding borrowing) in a given fiscal year. It is a measure of how much a government has to borrow to meet its expenses when its expenditure exceeds its revenue. In other words, when a government spends more than it earns in revenue (such as taxes, duties, and fees), it must borrow money to cover the shortfall. The amount of money the government borrows in a fiscal year to finance its deficit is known as the fiscal deficit. A fiscal deficit is an important indicator of a government’s fiscal health and its ability to meet its financial obligations. A high fiscal deficit can lead to an increase in government borrowing, which can result in higher interest rates, inflation, and a burden of debt for future generations.

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Budget Deficit

Budget deficit refers to the situation where a government’s total expenditure exceeds its total revenue (including borrowing) in a given period, typically a fiscal year.

In other words, a budget deficit occurs when a government spends more money than it generates in revenue, including both taxes and other sources of income such as fees and fines. Budget deficits can be caused by various factors, including an increase in government spending on programs or initiatives, a decrease in tax revenue due to an economic downturn or other external factors, or a combination of both. The impact of a budget deficit on the economy depends on various factors, including the size of the deficit, the nature of the government’s borrowing, and the overall economic conditions of the country. Generally, sustained budget deficits can lead to inflation, an increase in public debt, and a burden on future generations to pay off the debt. Governments can take measures to reduce budget deficits, such as cutting spending, increasing taxes, or implementing fiscal policies to boost economic growth and revenue generation. However, such measures can be politically challenging and have implications for various stakeholders, including taxpayers, investors, and the overall economy.

Monetized Deficit

Monetized deficit refers to the situation in which a government finances its budget deficit by printing new money or expanding the money supply, rather than borrowing from the public or other external sources. This is also known as deficit monetization or monetary financing of deficits. When a government monetizes its deficit, it effectively creates new money to pay for its expenses, which can lead to an increase in the money supply and inflationary pressures in the economy. This can occur when a central bank purchases government securities directly from the government, effectively creating new money to finance the budget deficit.

Primary Deficit

A primary deficit refers to a situation where a government’s expenses exceed its revenues in the absence of interest payments on existing debt. In other words, it’s the difference between a government’s spending and its tax revenues, excluding interest payments on its existing debt. A primary deficit can be an indication of a government’s fiscal imbalance, as it implies that the government is borrowing money to cover its expenses rather than relying on its own revenue sources. Addressing a primary deficit typically involves either reducing government spending, increasing taxes, or a combination of both.

Deficit Financing

Deficit financing refers to the practice of a government borrowing money to finance its spending when its expenses exceed its revenues. This can be done by issuing bonds, borrowing from banks or international institutions, or printing money. Deficit financing is often used during times of economic downturns or crises when government revenues decline, or when there is a need for increased government spending to support economic growth or provide social welfare programs. While deficit financing can stimulate economic activity, it also leads to an increase in government debt and interest payments, which can pose a long-term burden on the economy if not managed carefully. Governments may use deficit financing to fund a variety of initiatives, such as infrastructure projects, education and healthcare programs, and military spending. Deficit financing can help boost economic growth and create jobs, especially during times of recession or economic slowdowns when private sector investment is low.

Limits of Fiscal Deficit

A fiscal deficit refers to a situation where a government’s total expenses exceed its total revenues, including both tax revenues and non-tax revenues. While some level of deficit spending may be necessary for governments to fund important initiatives and stimulate economic growth, there are limits to how much fiscal deficit can be sustained before facing negative consequences. One limit of fiscal deficit is the risk of inflation. If a government borrows excessively or prints too much money to finance its spending, it can lead to an increase in the money supply, which can drive up prices and erode the value of the currency. This can have a negative impact on the economy, especially for low-income individuals who are disproportionately affected by rising prices.

Another limit of fiscal deficit is the risk of high levels of government debt. As a government borrows more to finance its spending, it accrues interest payments and principal that must be paid back in the future. High levels of debt can limit a government’s ability to borrow in the future, lead to higher interest rates, and place a burden on future generations. Fiscal deficits can also be limited by political factors. In some cases, deficit spending can be seen as a failure of fiscal management or a lack of political will to make tough choices about spending cuts or revenue increases. This can lead to political opposition to deficit financing and limit a government’s ability to borrow or spend.

Revenue Deficit Target Abolition: Pros and Cons

Revenue deficit target abolition refers to the proposal to eliminate the target of reducing the revenue deficit to zero by a certain year, which is currently mandated by the Fiscal Responsibility and Budget Management Act (FRBM) in India.

Pros:

• Flexibility: Abolishing the revenue deficit target would give the government more flexibility in terms of spending, as it would not be constrained by the need to achieve a zero revenue deficit by a certain year.
• Economic growth: The proposal could help boost economic growth, as increased spending on infrastructure, education, and other areas can create jobs and stimulate economic activity.
• Realistic targets: The current revenue deficit target of zero is considered by some to be unrealistic, given the challenges faced by the Indian economy.

Cons:

• Fiscal discipline: Abolishing the revenue deficit target could undermine fiscal discipline and lead to excessive spending, which could have negative consequences for the economy in the long term.
• Risk of crowding out: The proposal could also lead to a situation where government spending crowds out private investment.
• Rating agency concerns: Abolishing the revenue deficit target could lead to concerns among rating agencies and investors about the government’s commitment to fiscal discipline.

Twin Deficit Challenge

The Twin Deficit Challenge is a situation where a country faces both a fiscal deficit and a current account deficit at the same time. A fiscal deficit occurs when a government spends more money than it collects in revenue, while a current account deficit occurs when a country imports more goods and services than it exports, leading to a shortfall in the balance of payments.

When a country faces the Twin Deficit Challenge, it can create economic risks, including inflation, currency depreciation, and a loss of investor confidence. It can also limit the government’s ability to implement expansionary fiscal policies to stimulate the economy, as such policies may exacerbate the current account deficit.

Fiscal Stimulus

Fiscal stimulus refers to government policies aimed at increasing aggregate demand and boosting economic activity during periods of recession or slow growth. This typically involves increasing government spending or reducing taxes to provide a short-term boost to the economy. Fiscal stimulus measures can take various forms, such as public infrastructure spending, transfer payments to individuals and businesses, tax cuts, and subsidies. The goal of fiscal stimulus is to increase spending, which can lead to job creation, income growth, and increased consumption, ultimately leading to economic growth.

Monetary stimulus

Monetary stimulus refers to the actions taken by a central bank to increase the money supply and lower borrowing costs in order to stimulate economic growth. This can include measures such as reducing interest rates, purchasing government bonds or other assets, and providing liquidity to banks. Lowering interest rates is one of the primary tools used by central banks to implement monetary stimulus. When interest rates are lowered, it becomes cheaper for businesses and individuals to borrow money, which can increase spending and investment. Additionally, central banks can purchase government bonds or other assets to inject money into the economy and provide liquidity to banks to encourage lending. Monetary stimulus is typically used during times of economic recession or slow growth to encourage economic activity and job creation.

FRBM Act

The Fiscal Responsibility and Budget Management (FRBM) Act is a law enacted by the Indian government in 2003. Its main objective is to ensure fiscal discipline and reduce the fiscal deficit and revenue deficit of the central government of India. Under the FRBM Act, the government sets targets for reducing the fiscal deficit and revenue deficit to specific levels by certain target years. It also mandates the creation of a Fiscal Responsibility and Budget Management Committee to review the government’s fiscal policies and targets. The FRBM Act also requires the government to publish a Medium-Term Fiscal Policy Statement and a Fiscal Policy Strategy Statement every year, which outline the government’s fiscal policies and targets for the next few years.

Fiscal Consolidation

Fiscal consolidation refers to a set of policies and measures implemented by governments to reduce their fiscal deficits and stabilize their public finances. The goal of fiscal consolidation is to reduce the government’s reliance on borrowing and ensure sustainable economic growth. Fiscal consolidation measures typically involve a combination of expenditure reductions and revenue increases. This can include measures such as reducing government subsidies, increasing taxes, privatizing state-owned enterprises, and reducing public sector wages and benefits. Fiscal consolidation is often necessary when a government’s fiscal deficit and public debt levels have become unsustainable, leading to risks such as inflation, currency depreciation, and loss of investor confidence.

N.K. Singh Review Committee on FRBM

The N.K. Singh Review Committee on FRBM (Fiscal Responsibility and Budget Management) was a committee set up by the Indian government in 2016 to review the FRBM Act, which was enacted in 2003. The committee was headed by N.K. Singh, a former member of parliament and an expert in public finance. The committee’s main objective was to examine the effectiveness of the FRBM Act in achieving its objectives and suggest reforms to strengthen the fiscal framework in India. The committee submitted its report in January 2017, which made several recommendations, including a shift in focus from targeting fiscal deficit to targeting debt-to-GDP ratio, setting up of an independent fiscal council, and adopting a range for fiscal deficit targets instead of a fixed number. The government considered the committee’s recommendations and incorporated some of them in the Union Budget 2018-19.

Crowding Out

Crowding out is an economic phenomenon that occurs when increased government borrowing and spending results in reduced private investment. This happens when the government’s demand for funds to finance its spending leads to an increase in interest rates, making it more expensive for private individuals and businesses to borrow money. When interest rates rise due to increased government borrowing, private investors may reduce their investment or shift it to other countries where interest rates are lower. This can lead to a reduction in private-sector investment and economic growth.

Off Budget Financing

Off-budget financing refers to the use of funds that are not included in the government’s official budget to finance government projects and initiatives. These funds are usually generated from sources outside of the government’s regular revenue streams, such as loans from state-owned banks or revenue from public sector enterprises. Off-budget financing can be used for a variety of purposes, including infrastructure development, social welfare programs, and other public sector initiatives. It is often used by governments to fund projects that are considered politically important, but may not be feasible under the constraints of the official budget. While off-budget financing can provide a way for governments to fund important initiatives, it can also be risky. Because off-budget funds are not included in the official budget, they are often subject to less scrutiny and oversight, which can lead to misuse and corruption.

Budget Reforms

Budget reforms refer to changes made to the budgetary process and practices of a government. These reforms can include changes to the format, content, and transparency of the budget, as well as changes to the institutions and processes involved in the budgetary process. Some common budget reforms include the adoption of medium-term expenditure frameworks, which provide a multi-year perspective on government spending and help to improve fiscal discipline. Other reforms may include the use of program-based budgeting, which links funding to specific programs and activities, or the adoption of performance-based budgeting, which focuses on outcomes and results rather than inputs and outputs. Budget reforms can also focus on improving transparency and public participation in the budgetary process.

Zero Base Budgeting (ZBB)

Zero-based budgeting (ZBB) is a budgeting method that starts from zero for each budget cycle, requiring government agencies and departments to justify all spending, rather than simply building on past spending levels. Under ZBB, all expenditures must be justified on the basis of their contribution to the government’s goals and objectives, and funding is allocated based on priority. In contrast to traditional budgeting methods, which tend to focus on incremental changes to previous budgets, ZBB requires a more thorough analysis of each program or activity. This analysis involves identifying the most important goals and objectives, determining the resources needed to achieve them, and evaluating the costs and benefits of each program or activity. It can also help to reduce waste and eliminate unnecessary spending.

Outcome Budget

An outcome budget is a budget document that focuses on the results or outcomes of government programs and activities, rather than just the inputs or resources used to deliver them. The outcome budget typically includes information on the expected outcomes or results of each program or activity, as well as the funding allocated for these programs and the specific activities or initiatives that will be undertaken to achieve the desired outcomes. The outcome budget is intended to promote accountability and transparency in government spending by focusing on the results achieved through public expenditures. It can help to ensure that government resources are allocated efficiently and effectively to achieve desired outcomes and that taxpayers receive value for their money.

Gender Budgeting

Gender budgeting is a strategy for promoting gender equality and women’s empowerment through the budget process. It involves analyzing the budget and its impact on men and women and taking steps to ensure that budget decisions do not inadvertently reinforce gender inequalities. Gender budgeting can help to ensure that budget decisions are responsive to the needs and priorities of both women and men, and that government resources are used effectively to promote gender equality. It can also help to increase transparency and accountability in the budget process, by providing greater visibility into the gender dimensions of budget decisions.

Plan and Non-plan Expenditure Classification

Plan and non-plan expenditure classification is a budgetary classification system used in India to categorize government expenditure.

Plan expenditure refers to expenditure incurred by the government for the implementation of its Five-Year Plans, which are comprehensive economic and social development plans aimed at achieving specific targets over a five-year period. Plan expenditure is typically directed towards development programs, such as infrastructure projects, poverty alleviation schemes, and education and health initiatives.

Non-plan expenditure, on the other hand, refers to all other government expenditure that is not related to the implementation of Five-Year Plans. This includes expenditure on salaries and pensions, subsidies, interest payments, and defense spending.

Gross Domestic Savings

Gross Domestic Savings (GDS) is the total amount of savings generated within a country’s economy over a specific period of time. It is calculated as the difference between a country’s Gross Domestic Product (GDP) and its total consumption expenditure. In other words, GDS is the amount of income that households, businesses, and governments save after deducting their consumption expenditures. GDS is an important indicator of an economy’s capacity to finance investments and support long-term economic growth. It is a key factor in determining a country’s current account balance, which measures the difference between its exports and imports. A high level of GDS is generally associated with a positive current account balance and a lower dependency on foreign borrowing.

Factors of Gross Domestic Savings in India

Gross Domestic Savings (GDS) in India is influenced by various factors, including:

1. Income Levels: The level of income of households and businesses can affect their capacity to save. Higher-income levels may lead to higher savings rates.
2. Interest Rates: The interest rates on savings and borrowing can impact the savings behavior of individuals and businesses.
3. Demographics: The age distribution and population structure can also play a role in savings rates. For instance, a young population may have a lower propensity to save, while an aging population may have a higher savings rate.
4. Government Policies: Fiscal and monetary policies can influence savings rates. For instance, tax incentives for savings or low-interest rates can encourage individuals and businesses to save more.
5. Financial Inclusion: The availability of financial institutions, products, and services can influence savings rates. A well-developed financial system with access to credit and savings products can provide more opportunities for individuals and businesses to save.
6. Economic Growth: Strong economic growth can increase disposable incomes and create opportunities for investment, leading to higher savings rates.

Savings and Investment

Savings and investment are two related but distinct concepts in economics.

Savings refers to the portion of income that is not spent on consumption and is instead set aside for future use. Savings can be done by households, businesses, or governments, and it can take many forms, including bank deposits, mutual funds, stocks, and bonds.

Investment, on the other hand, refers to the use of saved funds to purchase capital goods that can generate future income and economic growth. Investment can be done by businesses, governments, or individuals, and it can take many forms, including buying real estate, building new factories, or investing in research and development.

Domestic Savings in India

Domestic savings in India refers to the total amount of savings generated within the country’s economy over a specific period of time. It includes the savings made by households, businesses, and the government. In India, savings are an important component of the economy, as it provides the funds required for investment in various sectors such as infrastructure, manufacturing, and agriculture. Domestic savings in India have increased in recent years, driven by higher income levels, low-interest rates, and government policies that promote savings.

Domestic Savings Trends in India

The trend in domestic savings in India has been fluctuating over the years, but it has generally been increasing in recent times. Here are some of the trends in domestic savings in India:

1. Increase in Savings Rate: The savings rate in India has been increasing steadily over the past few years. As per the latest available data from the Reserve Bank of India, the gross savings rate in India was 30.1% of the GDP in 2020-21, up from 29.6% in the previous year.
2. The shift from Physical to Financial Savings: There has been a shift from physical savings, such as gold and real estate, to financial savings in the form of bank deposits, mutual funds, and insurance. This trend is driven by increased financial literacy, greater access to financial products, and the convenience of digital platforms.
3. Demographic Changes: The changing demographic profile of India is also influencing savings trends. As the proportion of the working-age population increases, the overall savings rate is expected to rise. Additionally, the aging population is likely to save more for retirement, which will contribute to higher savings rates.
4. Government Policies: The government has introduced several policies to promote domestic savings, including tax incentives for savings, increased access to financial products, and the launch of savings schemes such as the Pradhan Mantri Jan-Dhan Yojana and Atal Pension Yojana.
5. Impact of COVID-19: The COVID-19 pandemic has had a mixed impact on domestic savings in India. On one hand, the lockdowns and economic slowdown have reduced income levels and forced people to dip into their savings. On the other hand, the pandemic has highlighted the importance of emergency savings, and many people have started to save more to build a financial cushion.

Small Savings

Small savings refer to financial instruments or schemes that are designed to encourage people to save their money for the long term. These schemes are typically offered by the government or financial institutions and are aimed at individuals who may not have access to formal banking services or who want to save small amounts of money regularly. In India, small savings schemes are quite popular, with millions of people investing in them. Some of the popular small savings schemes in India include the Public Provident Fund (PPF), National Savings Certificate (NSC), Kisan Vikas Patra (KVP), and Sukanya Samriddhi Yojana (SSY). These schemes offer attractive interest rates and tax benefits, making them an attractive investment option for many people.

Public Debt

Public debt refers to the total amount of money that a government owes to its creditors. This debt is incurred when a government borrows money from individuals, institutions, or foreign governments to finance its spending or investment programs. Public debt can be divided into two types: internal debt and external debt. Internal debt is owed to creditors within the country, such as banks and individuals, while external debt is owed to foreign creditors, such as other governments or international financial institutions. Public debt can be a useful tool for governments to finance their expenditures and stimulate economic growth, but excessive levels of public debt can also pose significant risks to the economy. High levels of debt can lead to higher interest rates, inflation, and reduced confidence in the government’s ability to repay its debt, which can undermine the economy’s stability and growth potential.

External Debt

External debt refers to the total amount of money that a country owes to foreign creditors, including other governments, international financial institutions, and private investors. This debt is typically incurred by governments to finance their spending or investment programs, or by private entities such as corporations or banks for various business purposes. External debt can take several forms, such as loans, bonds, and other types of securities issued in foreign currencies. Governments and other entities may borrow in foreign currencies when domestic interest rates are higher than those in foreign markets or when foreign investors are willing to lend at more favorable terms.

Rupee Debt

Rupee debt refers to debt that is issued and denominated in Indian rupees. This type of debt is typically issued by the Indian government, corporations, or financial institutions to raise funds for various purposes, such as financing infrastructure projects, expanding business operations, or meeting working capital needs. Rupee debt can take various forms, including bonds, debentures, and other types of securities. These securities typically offer fixed or variable interest rates and a maturity date, which determines when the borrower must repay the principal amount. Investors in rupee debt can be domestic or foreign, with foreign investors required to comply with certain regulations and restrictions on investment in the Indian debt market. The Reserve Bank of India (RBI) regulates the Indian debt market and sets guidelines and policies related to the issuance and trading of rupee debt.

Masala Bonds

Masala bonds are a type of bond denominated in Indian rupees and issued by foreign entities, such as companies or international organizations, in the Indian debt market. The term “masala” refers to the spiciness and Indian origin of the bonds. Masala bonds are issued to raise funds in Indian rupees, which can then be used to finance various projects, including infrastructure, renewable energy, and affordable housing. The issuance of masala bonds provides foreign entities with access to the Indian debt market and diversifies their funding sources. It also allows investors to invest in the Indian market without being exposed to currency risk, as the bonds are denominated in Indian rupees. The Reserve Bank of India (RBI) has established guidelines for the issuance of masala bonds, which include requirements related to the minimum maturity period, credit rating, and end-use of funds.

India and Sovereign Bonds

India issues sovereign bonds to raise funds from foreign investors to finance its fiscal and developmental needs. Sovereign bonds are debt securities issued by the government of a country, denominated in a foreign currency, and sold to investors in the international market. India began issuing sovereign bonds in 2019. The bonds are denominated in US dollars and are typically offered with long-term maturities of up to 10 years.

Sovereign bonds provide several benefits to the Indian economy, including access to a new source of funding, diversification of the investor base, and increased foreign exchange reserves. They also help to improve the country’s credit rating and reduce the country’s dependence on domestic sources of funding.

Sovereign Debt Crisis (SDC)

A sovereign debt crisis (SDC) refers to a situation where a country is unable to service its debts and faces a risk of defaulting on its sovereign debt obligations. This can happen due to a variety of factors, including excessive borrowing, poor fiscal management, economic downturns, or external shocks. An SDC can have severe consequences for the affected country, including a loss of investor confidence, a sharp depreciation of the currency, a rise in borrowing costs, and a decline in economic growth. To address an SDC, a country may need to implement a combination of policy measures, such as fiscal austerity, debt restructuring, or seeking external assistance from international organizations or other countries.

External Debt Management

External debt management refers to the strategies and policies that a country uses to manage its external debt, which is the debt that a country owes to foreign creditors. Effective external debt management involves balancing the need for foreign borrowing with the risks associated with excessive debt accumulation. Key components of external debt management include assessing external borrowing needs, negotiating the terms and conditions of borrowing, monitoring and managing external debt, and developing contingency plans for potential debt crises. Effective external debt management can help a country maintain access to international capital markets, reduce borrowing costs, and minimize the risk of debt distress or default.

NRI Bonds

NRI Bonds, or Non-Resident Indian Bonds, are fixed-income instruments issued by the Indian government to overseas Indians who want to invest in India. These bonds are denominated in Indian rupees and are targeted at Non-Resident Indians (NRIs) who are looking for investment options in India. NRI Bonds are generally considered to be safe investments as they are issued by the Indian government and backed by its creditworthiness. NRIs can invest in these bonds through their Non-Resident External (NRE) or Foreign Currency Non-Resident (FCNR) accounts. The interest earned on NRI Bonds is taxable in India, but NRIs are eligible for a tax exemption on interest income up to a certain limit. NRI Bonds are issued from time to time by the Reserve Bank of India (RBI) and are available through authorized banks and financial institutions.

Internal Debt

Internal debt refers to the amount of money that a government owes to its own citizens or institutions within its own country. This can include government bonds, treasury bills, and other forms of debt issued by the government to finance its operations, infrastructure projects, or other initiatives. Unlike external debt, which is owed to foreign creditors, internal debt is usually considered less risky as it is less subject to exchange rate fluctuations and political risks. However, high levels of internal debt can still have negative consequences for a country’s economy, including crowding out private investment and putting upward pressure on interest rates.

Debt-GDP Ratio

The Debt-to-GDP ratio is a measure that compares a country’s total debt to its gross domestic product (GDP). It is calculated by dividing a country’s total debt by its GDP and expressing the result as a percentage. This ratio is commonly used as an indicator of a country’s ability to pay off its debt, with higher ratios indicating a greater level of debt relative to economic output. A high Debt-to-GDP ratio can signal a country’s vulnerability to economic shocks, as well as the potential for higher interest payments on its debt, which can limit its ability to invest in other areas such as education, infrastructure, and healthcare. However, a high Debt-to-GDP ratio is not necessarily a cause for alarm, as it depends on various factors such as the country’s economic growth rate, inflation, and the nature of its debt.

State Development Loans (SDLs)

State Development Loans (SDLs) are bonds issued by state governments in India to finance their budgetary requirements or infrastructure projects. These bonds are issued to institutional investors such as banks, insurance companies, and mutual funds, and are generally exempt from income tax. SDLs are similar to central government securities, but they are issued by state governments instead of the central government. Each state has its own borrowing limit, which is determined by the Reserve Bank of India (RBI) based on various factors such as the state’s fiscal position and debt sustainability. The interest rate on SDLs is determined by market forces and is generally higher than the interest rate on central government securities due to the perceived higher credit risk associated with state governments.

WMAs, Special WMAs, and Overdraft

WMAs, or Ways and Means Advances, are short-term loans extended by the Reserve Bank of India (RBI) to the central government to bridge temporary mismatches in cash flow. The interest rate on WMAs is determined by the RBI and is generally lower than the interest rate on other short-term borrowing instruments such as Treasury Bills.

Special WMAs are a type of Ways and Means Advances provided to the central government in exceptional circumstances such as natural calamities, revenue shortfalls due to GST implementation, or unexpected fiscal developments. The interest rate on Special WMAs is higher than that on regular WMAs and is also determined by the RBI.

An overdraft is a short-term borrowing arrangement in which a bank allows its customer to withdraw more money from their account than they have available, up to a pre-approved limit. In the context of the central government, an overdraft facility is provided by the RBI to meet any temporary shortfall in the government’s cash balances. The interest rate on overdrafts is generally higher than the interest rate on WMAs and is also determined by the RBI.

Fiscal Drag

Fiscal drag is a situation that occurs when the government’s tax revenue increases due to inflation and rising incomes, without any corresponding adjustment in the tax brackets or rates. This results in taxpayers moving into higher tax brackets, leading to a reduction in their disposable income and a slowdown in economic growth. Fiscal drag can be seen as a form of implicit taxation, as it effectively increases the tax burden on taxpayers without any explicit change in the tax policy. Governments can reduce the impact of fiscal drag by adjusting their tax brackets and rates to reflect inflation and changes in income levels. Alternatively, they can also introduce policies to boost economic growth and prevent inflationary pressures from pushing taxpayers into higher tax brackets.

Fiscal Cliff

A fiscal cliff refers to a situation where a combination of government policies, such as tax increases and spending cuts, occur simultaneously, leading to a sharp reduction in a country’s economic output. This can occur when a government attempts to reduce its budget deficit or debt levels by implementing austerity measures, but the measures are too sudden or severe, leading to a contraction in economic activity.

In the United States, the term fiscal cliff was widely used in 2012 to describe a combination of tax increases and spending cuts that were set to take effect at the beginning of 2013, if the government failed to reach an agreement on deficit reduction. The fear was that the simultaneous implementation of these measures would cause a severe economic contraction, which could have had significant negative consequences for the US and global economies. Governments can avoid a fiscal cliff by adopting a more gradual approach to fiscal consolidation, such as by implementing a mix of spending cuts and tax increases over a longer period, which can give the economy time to adjust. They can also consider implementing policies that support economic growth, such as infrastructure spending and tax incentives for businesses.

Important Questions on Fiscal Policy

Questions 1
Fiscal Policy is concerned with [MPPSC (Pre) 1996]
(A) the volume of currency that banks should put in the economy
(B) the policy regarding taxation and expenditure
(C) policy for regulating stock
(D) the policy for dealing with IMF

Questions 2
Which one of the following is part of fiscal policy? [UKPCS (Pre) 2014]
(A) Production policy
(B) Tax policy
(C) Foreign policy
(D) Interest rate policy

Questions 3
Which one of the following is NOT the objective of fiscal policy of government of India? [HCS (Pre) 2014]
(A) Full employment
(B) Price stability
(C) Regulation of inter-state trade
(D) Economic growth

Questions 4
In India, which one among the following formulates the fiscal policy? [UPPCS (Mains) 2014]
(A) Planning Commission
(B) Finance Commission
(C) Finance Ministry
(D) Reserve Bank of India

Questions 5
Which of the following economists, introduced fiscal policy as a tool to rectify the Great Depression of 1929-30? [UKPCS (Pre) 2014]
(A) Prof. Keynes
(B) Prof. Pigou
(C) Prof. Marshall
(D) Prof. Crowther

FAQs on Fiscal Policy

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