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Deficit Financing in India #DeficitFinancingInIndia

Background

  •   After independence India went for planned economy and so development responsibilities of the government were very high.
  •   This created a need for huge funds in rupee as well as in foreign currency forms.
  •   But India faced continuous crisis in managing the required fund to support its Five Year Plans because neither foreign funds came nor internal resources could be mobilized in sufficient amount due to lower tax collections, weaker banking system and negligible saving rate, etc.
  •   And so India headed towards deficit financing from late 1960s.
  •   Deficit financing in India was in following 3 phases –

     

 

First phase (1947-1970)

  •   No concept of deficit financing
  •   Tried internal and external borrowing but unable to meet the target.
  •   In the 1950s, tried to increase tax collections and check revenue expenditures to emerge as a surplus revenue budget economy but didn’t get success.
  •   Heavy borrowings from the RBI and nationalization of banks increased the interest burden of the governments and ruptured the whole financial system

 

Second Phase (1970-1991)

  •   It was period where India adopted deficit financing
  •   Nationalization policy (control of government like nationalization of banks)
  •   Emphasis on expansion of the PSUs. But PSUs were in huge loss because of low revenues, high salary burden, PFs, and pensions.
  •   No check on rising population and no mass employment generations.
  •   Subsidies increased exponentially due to populist measures
  •   Majority of plan expenditure became non-economic i.e. non-plan expenditure

 

Third Phase (1991 onwards)

  •   Initiation of the economic reforms process under the conditionalities put forth by the IMF.
  •   As the economy moved from government control to market dominance, things needed a restructuring and public finance also needed a touch of rationality.

 

Indian Fiscal Situation – a Summary

  •   In 1985 – GoI presented a discussion paper in parliament titled ‘Long Term Fiscal Policy’
  •   It was a long term perspective on the fiscal issue of government.
  •   It recognizes the deterioration in India’s fiscal position and accepted it among the most important challenges of the 1980s.
  •   It set specific targets and policies to set the things right.
  •   In 1987 – government come with 2 bold steps – one, virtual freeze on government expenditure and another ceiling on the budgetary deficit.
  •   But they created temporary positive impact and since mid-1988 the situation again started deteriorating and 1990 saw BoP crisis because of high fiscal deficit and due to a high level of external borrowings.
  •   IMF supported India in crisis but with conditions.
  •   With the process of economic reforms which started in 1991-92, the government also

    announced its commitment to reduce fiscal deficit to 3-4% (of GDP) by the mid-1990s.

  •   India’s fiscal situation up to the 1990-91:
    •   Fiscal deficit keeps on increasing. It was 4% of GDP in 1970s and went to 7% in second half of 1980s
    •   The revenue (i.e., current) expenditure of the government (Centre and states combined) increased from 11.8% of GDP to 23% between 1960 and 1990. The revenue receipts of the government also went up. But the gap between revenue receipts and expenditures remained negative (i.e. Revenue deficit)-financed largely by domestic borrowings.
    •   The fiscal situation of the states was not good either. The states’ expenditure on the social sector went down while their interest payments had increased during the 1980s.
    •   The debt situation in the states would have been even worse, but for the fact that the states, unlike the Centre, did not have independent powers to borrow either from the RBI or the market because of the statutory overdraft regulatory scheme. (Now this scheme has changed. After the implementation of suggestions of 12th FC states are now allowed to go for market borrowings to take care of their plan expenditures once they have passed and enacted their Fiscal Responsibility Acts (FRAs) in consonance with the FRBM Act, 2003.)

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