Fiscal Policy in India: Budget, Deficits, FRBM Act, Types & UPSC PYQs

This topic of ‘Fiscal Policy in India’ is important from the perspective of the UPSC IAS Examination, particularly under General Studies Paper III (Indian Economy), Budgeting, Public Finance, and Economic Development.

Fiscal Policy in India

• Fiscal policy in India refers to the government’s strategy in using taxation, public spending, and borrowing to influence macroeconomic conditions such as economic growth, employment, inflation, and income distribution. 

• Fiscal policy can be expansionary or contractionary in nature. 

• An expansionary fiscal policy involves increasing government spending or reducing taxes to boost demand and stimulate economic activity, especially during slowdowns or recessions. 

• A contractionary fiscal policy is used to cool down an overheated economy and control inflation by reducing spending or increasing taxes.

• Fiscal policies can also be cyclical, aligning with the natural economic cycle, or counter-cyclical, where the government takes steps opposite to the economic trend.

• Cyclical Fiscal Policy: Moves in the same direction as the economic cycle (e.g., spending more and reducing taxes during a boom).

• Counter-Cyclical Fiscal Policy: Moves against the economic cycle to stabilize the economy (e.g., spending more during a slowdown and cutting back during a boom).

Union Budget Article 112 (Annual Financial Statement)

• As per Article 112 of the Indian Constitution, the President is required to lay before both Houses of Parliament the Annual Financial Statement, commonly known as the Union Budget, which provides an estimate of the government’s receipts and expenditure for the upcoming financial year.

• The Union Budget is prepared by the Department of Expenditure under the Ministry of Finance. This department is responsible for estimating revenues and expenditures, coordinating with various ministries and departments, and ensuring that the budget aligns with the fiscal policy objectives of the government.

Classification Of Budget

Union Budget is broadly classified into two parts:

Capital Budget: 

• Capital Expenditure: Capital Expenditure refers to those government expenditures that either increase assets (financial or physical) or decrease liabilities. This includes:

• Infrastructural costs, Setting up new PSUs (Public Sector Undertakings)

• Purchase of shares, Repayment of loan principal, Government giving new loans

• Capital Receipts: Capital Receipts are receipts that either reduce assets or increase liabilities. This includes:

• New borrowings, Repayment of previous loans, Disinvestment (selling of government shares in PSUs)

Revenue Budget:

• Revenue Expenditure: Revenue Expenditure refers to those government expenditures that neither increase assets nor decrease liabilities. This includes:

• Salaries, Pensions, Subsidies, Interest payments, Grants paid

• Revenue Receipts: Revenue Receipts are receipts that neither reduce assets nor increase liabilities. This includes: Tax receipts, Interest received, Dividends, Fees, Fines, Grants received

Also Read: Union Budget 2026-27: Key Highlights and Process

Types of Deficits in the Government Budget:

Here are types of Government Budget; 

• Revenue Deficit:

• It represents the shortfall of revenue receipts in comparison to revenue expenditure, indicating that the government is unable to cover its routine expenses from its income.

• Revenue Deficit =Revenue Expenditure −Revenue Receipts

• Fiscal Deficit:

• It is the gap between the government’s total expenditure and its total revenue (excluding borrowings). It signifies the extent to which the government relies on debt to finance its activities.

• Formula: Fiscal Deficit = Total Expenditure − (Revenue Receipts+Non-debt Capital Receipts)

• Effective Revenue Deficit (ERD):

• Introduced in the Union Budget 2011-12, ERD accounts for the portion of revenue deficit used for capital asset creation.

• Formula: Effective Revenue Deficit = Revenue Deficit − Grants for Capital Asset Creation

• Budget Deficit:

• It occurs when total government expenditure exceeds total revenue, including borrowings and other sources of funds.

• Unlike fiscal deficit, budget deficit is not used in official calculations in India since the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 mandates reporting fiscal and revenue deficits.

• Primary Deficit:

• It indicates the government’s borrowing requirement excluding interest payments on past debt.

• Formula: Primary Deficit = Fiscal Deficit − Interest Payments.

Fiscal Responsibility & Budget Management Act (FRBM Act 2003)

• It is a legislation enacted by the Indian Parliament to institutionalise financial discipline, reduce fiscal deficits, and improve macroeconomic management.

• Its main aim is to ensure fiscal prudence and long-term debt sustainability by setting targets for the government’s borrowing, deficits, and debt. 

• There is a time inconsistency problem, i.e. governments are likely to spend more on populist measures/ schemes when elections are nearby. Thus, government discretion is curbed by the FRBM Act. 

• Key Features:

• Fiscal Deficit Target:

• The central government must reduce the fiscal deficit to 3% of GDP (as per the original target).

• Revenue Deficit:

• Target to eliminate revenue deficit over time, ensuring borrowings are used for investment and not routine expenses.

• Government Debt:

• The Centre should work to reduce its total outstanding debt as a percentage of GDP.

• Based on NK Singh Committee recommendations, following debt targets were adopted:

• The 2018 update (FRBM Amendment) set a debt target of 40% of GDP for the central government.

• The 2018 update (FRBM Amendment) set a debt target of 20% of GDP for the state government. (This statement is not explicitly mentioned in the act though)

• Thus, general government debt needs to be kept under 60% of GDP.

• Transparency:

• The government must present medium-term fiscal policy, fiscal policy strategy, and macroeconomic framework statements every year with the Union Budget.

• Escape Clause:

• Under extraordinary situations (e.g., natural disaster, national security threat, severe economic slowdown, structural reforms), the government can relax fiscal targets temporarily.

• Additional Guarantee:

• The central government should not provide additional guarantees of more than 0.5% of GDP in any financial year.

• Debt Monetization:

• Under no circumstances shall the Reserve Bank of India subscribe to the primary issuance of government securities, thus preventing direct monetization of debt.

Drawbacks of the FRBM Act

• The FRBM Act does not prescribe any legal sanctions if the government fails to maintain fiscal discipline.

• When the government invokes the escape clause, the Act does not specify a time limit within which it must restore the prescribed fiscal deficit targets.

Financing Fiscal Deficit

The fiscal deficit is financed through:

• Internal borrowings

• External borrowings

Internal Borrowings (Domestic Sources)

• The government issues Government Securities (G-Secs).

• These are subscribed by Households (via Retail Direct Scheme), Firms, and Financial institutions.

• Borrowings from these domestic sources form the Government’s Internal Debt.

External Borrowings (Foreign Sources)

• Foreign Institutional Investors (FIIs) can also buy G-Secs in the Indian market → counted as External Debt.

• Other external borrowing sources include:

• Multilateral institutions (e.g., World Bank, IMF)

• Bilateral arrangements (from other countries)

These borrowings are classified as Sovereign External Debt.

Public Debt:

• All borrowings made against the Consolidated Fund of India are classified as Public Debt.

Public Account Surplus:

• Fiscal deficit is also financed through surpluses in Public Account, which include National Small Savings Fund (NSSF), Post Office deposits, National Savings Certificates (NSC), Public Provident Fund (PPF), State Provident Funds, Other Accounts: Pension funds, insurance funds, etc.

UPSC Previous Year Questions and Practice Questions

UPSC Mains Question

Q. Explain how the Fiscal Health Index (FHI) can be used as a tool for assessing the fiscal performance of states in India. In what way would it encourage the states to adopt prudent and sustainable fiscal policies? (250 Words, 15 Marks)

Q. What were the reasons for the introduction of Fiscal Responsibility and Budget Management (FRBM) Act, 2003? Discuss critically its salient features and their effectiveness. (200 words, 10 marks)

Fiscal Policy in India PYQs

Q1. With reference to the expenditure made by an organization or a company, which of the following statements is/are correct ? (2022)

1. Acquiring new technology is capital expenditures.

2. Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure.

Select the correct answer using the code given below.

1. 1 only

2. 2 only

3. Both 1 and 2

4. Neither 1 nor 2

Answer: A

Exp: 

Acquiring new technology, machinery, patents, or software with long-term utility is generally treated as capital expenditure.

Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure. 

Q2. There has been a persistent deficit budget year after year. Which action/actions of the following can be taken by the Government to reduce the deficit? (2016)

1. Reducing revenue expenditure 

2. Introducing new welfare schemes 

3. Rationalising subsidies 

4. Reducing import duty 

Select the correct answer using the code given below. 

1. 1 only 

2. 2 and 3 only 

3. 1 and 3 only 

4. 1, 2, 3 and 4 

Answer: C

Reducing revenue expenditure → Lowers government spending and helps reduce the fiscal deficit. 

Introducing new welfare schemes → Increases government expenditure and widens the fiscal deficit. 

Rationalizing subsidies → Cuts government spending and helps reduce the fiscal deficit. 

Reducing import duty → Lowers tax revenue, which tends to increase the fiscal deficit. 

Q3. Which one of the following is responsible for the preparation and presentation of Union Budget to the Parliament?(2010)

1. Department of Revenue

2. Department of Economic Affairs

3. Department of Financial Services

4. Department of Expenditure

Answer: B

The Union Budget is prepared and presented by the Budget Division of the Department of Economic Affairs (DEA) under the Ministry of Finance.