Introduction
Fiscal policy refers to the use of government spending and taxation to influence the economy. In the Indian context, the government balances fiscal discipline with the need for growth, as mandated by the Fiscal Responsibility and Budget Management (FRBM) Act.
Why in News?
The global economic climate, characterized by high debt-to-GDP ratios, has brought fiscal consolidation back into focus. The Indian government is currently adhering to a fiscal glide path to lower the fiscal deficit to below 4.5 percent of GDP by 2025-26.
Static Link
Fiscal policy is a core GS Paper III subject. The FRBM Act, 2003, is the primary legal instrument for fiscal management in India. UPSC often focuses on the distinction between revenue and capital expenditure, as well as the impact of deficit financing on interest rates and inflation. Candidates should be familiar with the concepts of fiscal multipliers and debt sustainability.
Institutional Link
The Ministry of Finance, specifically the Department of Economic Affairs, formulates fiscal policy. The Finance Commission is a constitutional body (Article 280) that recommends the distribution of net proceeds of taxes between the Centre and States. The N.K. Singh Committee was established to review the FRBM Act. Note: The Finance Commission focuses on vertical and horizontal devolution, whereas the FRBM Act sets legislative fiscal targets.
Core Prelims Facts
- Fiscal Deficit: The government aims to reach a fiscal deficit of below 4.5 percent of GDP by 2025-26.
- Capital Expenditure: Expenditure that creates physical or financial assets or reduces financial liabilities. It has a higher multiplier effect on GDP.
- Revenue Expenditure: Expenditure incurred for normal running of government departments and various services (e.g., salaries, subsidies, interest payments).
- Fiscal Glide Path: The multi-year plan adopted by the government to reduce the fiscal deficit gradually.
Important Terms and Concepts
- Crowding-in Effect: A phenomenon where increased government spending leads to higher demand, encouraging private sector investment.
- Crowding-out Effect: A situation where increased government borrowing leads to higher interest rates, which reduces (or crowds out) private investment.
- Multiplier Effect: The proportional amount of increase in final income that results from an injection of spending.
Bodies / Organisations / Institutions
- Ministry of Finance: Responsible for the administration of fiscal policy.
- Finance Commission: Constitutional body ensuring fiscal federalism.
- FRBM Review Committee: An expert body tasked with reviewing fiscal rules and targets.
Schemes / Laws / Reports / Conventions
- FRBM Act, 2003: A legislation enacted to ensure fiscal prudence, eliminate revenue deficit, and bring down fiscal deficit.
Possible UPSC Prelims Traps
- Confusing the role of the Finance Commission with the FRBM Act targets.
- Assuming all government expenditure has the same multiplier effect.
- The trap of absolute terms like only in relation to austerity measures; austerity is often a mix of spending cuts and revenue enhancement.
- Geography or location traps are generally not applicable to this fiscal policy topic.
One-Minute Revision Notes
- FRBM Act enacted in 2003 for fiscal discipline.
- Target: Fiscal deficit below 4.5% of GDP by 2025-26.
- Capital expenditure stimulates long-term growth more than revenue expenditure.
- Fiscal consolidation is essential for maintaining credit ratings and macroeconomic stability.
- Crowding-in: Government spending helps private sector growth.
Practice MCQ for Prelims
1. With reference to government expenditure in India, what is the 'crowding-in' effect?
A. Reduction in government spending to allow private sector dominance.
B. Government investment in infrastructure stimulating private sector investment.
C. Government borrowing leading to an increase in interest rates for private firms.
D. A decrease in GDP growth due to excessive public sector borrowing.
Answer: B
Explanation: Crowding-in occurs when public spending on infrastructure and services improves the investment climate, thereby encouraging private businesses to invest.
Original Article: https://indianexpress.com/article/upsc-current-affairs/upsc-essentials/what-indias-current-economic-challenges-reveal-about-austerity-10718799/
Full Current Affairs Analysis: https://iasment.com/understanding-the-dynamics-of-fiscal-austerity-and-economic-growth-mains-specific/