MEPP Lectures 13-14-15

Fiscal Policy Reforms

In India since 1991

Presented by
Dr. Tarun Das
Professor, IILM

Fiscal Policy Reforms 1

1. Characteristics of Reforms
•Gradual and Step by Step Approach
not a Big Bang or Shock Therapy
Approach
•Democratic and political constraint
•Strong emphasis on “human face”
•Least sacrifice made by people
•No write-off or rescheduling of
external debt
•Agency constraint and No
backtracking
•Nationality constraint
•Ownership of reforms
Fiscal Policy Reforms 2
 2.1 Motivation for Fiscal
Reforms
• Large fiscal deficits and automatic
monetization of deficits leading to high
inflation and high interest rates and
crowding out private investment.
• High and irrational tax rates, high tariff
walls led to industrial inefficiency, lack of
competitiveness, high cost economy and
non-optimal allocation of resources.
• Large variance and multiplicity of tax
rates on the basis of end-uses led to
complicated and weak tax administration
and rent seeking.
Fiscal Policy Reforms 3
 2.2 Motivation for Fiscal Reforms

• Low buoyancy and elasticity of both

direct and indirect taxes.
• Complicated tax structure, legal laws,
rules and procedures.
• Low compliance rate, high degree of
tax evasion, low administrative
efficiency.
• Narrow tax base and greater
dependence on indirect taxes leading
to inequity
• Change in the role of the government
from operator to regulator, supplier of
Fiscal Policy Reforms 4
goods and services to facilitator.
 2.3 Motivation for Fiscal
Reforms
• Liberalization of trade, industry, investment
• Emphasis of social services and safety net in the context
of so-called LPG (liberalization, privatization and
globalization).
• Public sector enterprises reforms and disinvestment of
government equity.
• Integration of monetary, exchange rate, regulatory and
other policies.
• Globalization and Regionalization of economic activities.
• Impact of WTO, SAARC, BTAs and FTAs.

Fiscal Policy Reforms 5

 2.4 Motivation for Fiscal
Reforms
• Demographic change (social security
and health care for senior citizens and
reforms in pensions, provident and
insurance funds).
• Fiscal federalism, Centre-state
relations, decentralization, grass root
planning, Panchayati Raj.
• To tackle environment degradation
through filth tax /environment tax.
• IMF/ World Bank/ ADB conditionalities
for reforms and fiscal sustainability.
Fiscal Policy Reforms 6
 3.1 Major Fiscal Reforms
• Reduction of fiscal deficit
• Fiscal Responsibility and Budget
Management Act 2003
• Simplifying rules and procedures
• Strengthening tax administration
• Widening tax base & enhancing
buoyancy
• Rationalisation and Reduction of both
direct and indirect tax rates

Fiscal Policy Reforms 7

 3.2 Fiscal Responsibility and
Budget Management (FRBM) Act
2003
• FRBM Act 2003 and FRBM Rules 2004 came
into force w.e.f. 5 July 2004.
• The Act mandates the Central govt to
eliminate revenue deficit by March 2009 and
to reduce fiscal deficit to 3% of GDP by March
2008.
• Under section 7 of the Act, the central govt is
required to lay before both houses of
Parliament Medium Term Fiscal Policy
Statement, Fiscal Policy Strategy Statement
and Macro Economic Framework Statement
along with the Annual Financial Statement and
Demand for Grants.

Fiscal Policy Reforms 8

 3.3 FRBM Rules 2004

• Reduction of revenue deficit by 0.5% of GDP

or more every year.
• Reduction of gross fiscal deficit by 0.3% of
GDP or more every year.
• No assumption of additional debt exceeding
9% of GDP for 2004-05 and progressive
reduction of this limit by at least one
percentage point of GDP in each subsequent
year.

Fiscal Policy Reforms 9

 3.4 FRBM Rules 2004
• No guarantee in excess of 0.5% of GDP in
any financial year.
• Four fiscal indicators to be projected for the
medium term. These include revenue
deficit, fiscal deficit, tax revenue and total
debt as % of GDP.
• Greater transparency in the budgetary
process, rules, accounting standards and
policies having bearing on fiscal indicators.
• Quarterly review of the fiscal situation.

Fiscal Policy Reforms 10

 3.5 FRBM Rules 2004
• The rules mandate the Central Government
to take appropriate collective action in the
case of revenue and fiscal deficits
exceeding 45% of the budget estimates, or
total non-debt receipts falling short of 40%
of the budget estimates at the end of half
year of the financial year.
• The rules also prescribe the formats for the
mandatory statements.

Fiscal Policy Reforms 11

 3.6 Macro-economic
Background for Budget 2006-07
Major macro-economic 2005- 2006-07
variables 06 Projected

1. Real GDP growth rate 8.4 8.0

2. WPI Inflation rate (%) 4.4 5.0
3. Fiscal deficit / GDP (%) 4.1 3.7

4. Revenue deficit/GDP 2.6 2.1

(%)
5.Primary deficit/GDP (%) 0.5 0.2

Fiscal Policy Reforms 12

 3.7 Medium Term Fiscal
Indicators
Items 2005-06 2006- 2007- 2008-
RE 07 BE 08 Tar 09 Tar
1.Revenue Deficit as 2.6 2.1 1.0 0.0
% of GDP
2.Fiscal Deficit 4.1 3.7 3.4 3.0
as % of GDP
3.Gross tax rev. 10.5 11.2 11.5 11.8
as % of GDP
4.Year-end debt 65.7 65.7 64.4 63.1
stock (% of GDP)
Fiscal Policy Reforms 13
 3.8 Recommendations of the
Twelfth Finance Commission (1)
 Fiscal deficit to GDP for the Centre and
States be targeted at 3%.
 Revenue deficit f the Centre and States be
reduced to zero by 2008-09.
 State’s recruitment policy must ensure that
salary bill as % of revenue exp, net of interest
payments, is within 35%.
 Each State must enact Fiscal Responsibility
bill to reduce fiscal deficit to SDP ratio to 3%
and revenue deficit to zero by 2008-09.

Fiscal Policy Reforms 14

 3.9 Recommendations of the
Twelfth Finance Commission (2)
 States’ share in net proceeds of shareable
central taxes be increased from 29.5% to
30.5%.
 Indicative amount of overall transfers to
States be fixed at 38% of the Centre’s gross
revenue receipts.
 A grant of Rs.20,000 crore for Panchayati Raj
Institutions and Rs.5,000 crore for urban local
bodies to be given to States for the period
2005-2010.

Fiscal Policy Reforms 15

 4.1 Progress of Fiscal
Reforms
Status in June 1991 Status in January 2007
(a)Budget support to (a) Support reduced to
PSEs: 1.5% of GDP 0.5% of GDP
(b) Price and purchase (b)No price preference,
preference for PSEs but purchase
(c )Preferential treatment preference exists
for bank credits (c )No preferential treat-
(d) No hard budget ment for bank credits
constraints for PSEs (d) MOUs strengthened
(e) No disinvestment (e) Divestment allowed
(f)SICA does not include (f)SICA applicable for
sick PSUs PSUs
Fiscal Policy Reforms 16
 4.2 Fiscal Deficit (as % of
GDP)
Status in 2005-06
Status in 1990-91
Central Govt Central Govt
Fiscal Deficit 6.6% Fiscal Deficit 4.1%
Revenue deficit 3.3% Revenue deficit 2.6%
Primary deficit 2.8% Primary deficit 0.5%
State governments State governments
Fiscal Deficit 3.3% Fiscal Deficit 3.3%
Revenue deficit 0.9% Revenue deficit 0.5%
Primary deficit 1.8% Primary deficit 0.7%

Fiscal Policy Reforms 17

 4.3 Fiscal Deficit as % of GDP
Status in 1990-91
General government
Fiscal Deficit 9.4%
Revenue deficit 3.3%
Primary deficit 2.8%
• Monetization of budget
deficit
• Control on interest rate
on government
securities
Status in 2005-06
General government
Fiscal Deficit 7.3%
Revenue deficit 3.1%
Primary deficit 1.2%
• No automatic
monetization
• Govt securities are
auctioned and sold at
market prices

Fiscal Policy Reforms 18

 4.4 Progress of Fiscal
Reforms
Status in June 1991 Status in March 2006
• Public debt as • Public debt as
percentage of GDP percentage of GDP
(a) Central govt 61% (a) Central govt 66%
- Internal 50% - Internal 60%
- External 12% - External 6%
(b) States 19% (b) States 33%
- Internal 19% - Internal 33%
(c )General govt 68% (c )General govt 99%
- Internal 56% - Internal 93%
- External 12% - External 6%
Fiscal Policy Reforms 19
 4.5 Progress of Fiscal
Reforms
Status in January 2007
Status in June 1991
Fiscal Deficit was (a) Ad hocs replaced by
WMAs at market rate
financed by:
(b) SLR reduced to 25%
(a) RBI Ad Hoc TBs at and CRR 5%
4.6% interest (c)Govt. securities are sold
(b) Banks through SLR at market rates
holdings at 38.5% (d) Reduction of interest
and CRR 25% rates for public funds
(c ) Market borrowings (e) Less dependence on
External debt
(d) Public funds
(e) External debt
Fiscal Policy Reforms 20
 4.6 Progress of Fiscal
Reforms
Status in January 2007
Status in June 1991
Duties & taxes reduced
High duty & tax rates
Maximum rates
Maximum rates Excise duty 16% Cenvat + 16%
Excise duty 110% SED
Import duty 12.5%
Import duty 400% Income tax 30%
Income tax 54% Corporate taxes:
Corporate taxes: Domestic COs. 30% + 10%
surcharge
Domestic COs. 49%
Foreign COs. 40%+2.5%
and 54% surcharge
Foreign COs. 65%
Fiscal Policy Reforms 21
 4.7 Progress of Fiscal
Status in June 1991
Reforms
Status in January 2007
• No service tax • Service tax @12%
• MAT introduced
• No MinAlternativeTax
• Trans. tax @0.02%+25%
• No transactions tax increase in 2006-07
• No tariff value • Tariff value introduced
• Dividend tax on both • Dividend tax on only
individuals & Cos. companies
• Existence of gift tax • Gift tax abolished
Tax holidays widened to
• Limited cases of tax- • many infrastructure
holidays
• FBT imposed
• No fringe benefit tax
(FBT)

Fiscal Policy Reforms 22

 4.8 Progress of Fiscal
Reforms
Status in January 2007
Status in June 1991
• No MRP linked • Concept of MRP introduced
for consumer goods
excise duties
• Estimated income scheme
introduced for retail traders.
• No estimated
• Presumptive income tax
income scheme for scheme introduced
retail traders • State level VAT introduced
• No presumptive tax wef April 05

• No state level VAT

Fiscal Policy Reforms 23

 4.9 Related Financial
Reforms
Status in June 1991 Status in January 2007
• CRR 25% • CRR 5%
• SLR 38.5% • SLR 25%
• Bank Rate 12% • Bank rate 6%
• PLR 11% to 11.5%
• PLR above 21%
• Deposit and interest
• Deposit and interest
rates are liberalised
rates are controlled
• The office of CCI
• Capital issues and abolished and SEBI
prices determined by established
the CCI in MOF

Fiscal Policy Reforms 24

 4.10 Related Financial
Reforms
Status in January 2007
Status in June 1991
• Indian firms not • Indian firms allowed to
raise foreign funds by
allowed to raise funds
GDR, ADR, FCCBs &
from foreign stock
offshore funds
exchanges
• FIIs, NRIs and OCBs
• Portfolio investment allowed to buy stocks in
by foreign investors in Indian markets s.t.
Indian companies not overall limit of 49%
allowed • FIIs/ NRIs/ OCBs allowed
• Foreigners not to buy G-secs
allowed to buy G-secs
Fiscal Policy Reforms 25
 5.1 Second Generation Fiscal
Reforms
 Coordinating state level reforms
 Accelerated privatisation
 Development of debt and bond markets
 Reforms in Insurance, Provident and Pension
funds
 Thrust on state provision of basic needs
 Rationalisation of user charges for public utilities
 Rationalisation of subsidies

Fiscal Policy Reforms 26

 6. Concluding Remarks
 Transparency and accountability of
budget formulation
 Multi-year budget and macro-economic
forecast
 Adequacy and sustainability of policies
 Willingness to pay by stakeholders
 Strengthening institutional set up

Fiscal Policy Reforms 27

 Thank you
Have a Good Day

Fiscal Policy Reforms 28