IGNOU's Public Administration Material Part-5 Financial Administration
IGNOU's Public Administration Material Part-5 Financial Administration
IGNOU's Public Administration Material Part-5 Financial Administration
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UNIT 1 NATURE ANDSCOPE OF
FINANCIAL ADMINISTRATION
.,
' Structure
Objectives
Introduction
Financial Administration : Meaning
Financial Administration : Importance
Nature of Financial Administration
Scope of Financial Administration
Components of Financial Ad~inistration
Let U S ' S U b~ p
Key Words
References
Answers to Check Your Progress Exercises
1.O OBJECTIVES
After studying this unit, you should be able to :
discuss the meaning, importance of financial administration
explain the nature of financial administration
highlight the enlarging scope of financial administration; and
identify the components of financial administration.
1.1 INTRODUCTION
Finance is the life blood of every organisation; Personnel and materials which are
needed for the functioning of any office, industry, enterprise can be made available
only if money is provided.
The efficiency of operating systems and maintenance systems depends upon the
effectiveness of financial system as every administrative act may have financial
implications. The significance of finance to public administration is quite obvious as
is evident from the remark of Lloyd George: "Government is finance".
Financial administration, as an important aspect of public administration islas anc~ent
as organised governments all over the world. In its rudimentary form, it was
*
performing certain limited functions till medieval times. In the pre-modern times, it
was conceived within the structure of legislative control over executive.
Soqio-economic forces unleashed by industrial revolution have given a new meaning
i and a dynamic content to financial administration. In the changed context, it is
I expected to meet dynamic needs of planned development and social change.
!
In this unit we shall discuss the meaning, importance, nature and scope of Financial
Administration. The unit will also give us an idea about the various components of
I Financial Administration.
'L
The importance of Financial Administration was not considered till after industrial
revolution. The concept of minimum government as an offshoot of laissez faire
doctrine, dictated observance of minimum taxation. When social life became more
complex as a result of industrial revolution, the role of the government increased
manifold. Further, the concept of welfare state has caused phenomenal increase in
state activity. The governments have entered into new areas which were kept out of
the purview of the State. In this changed context, financial administration has gained
greater significance for exploring ways and means to generate resources to meet the
ever-increasing public expenditure.
The Great Depression (1929-33) had exposed the weaknesses of neutral economic
stance of the governments. It enhanced the quest for stability in income and
employment as well as for equality and social justice. Based on Keynesian
perspective, the State has assumed an active and positive role for expanding national
income and employment. It has also taken up the task of ensuring equity and
eniialitv Ficral nnlirv o f the o n v e r n m ~ n thac hprnrnp a n n w p r f i ~ inctnirn~nt
l in
~nfluencingthe socio-economic life of the people. Defence and administrative Nabre and Scope of Financial
AdmlnistraUon
expenditure ldst its nonproductive label and assumed a new significance as a lever
for stimulating iricome and employment levels. Financial administration was
entrusted with the responsibility of formulating effective policies to achieve these new
objectives of the State. It was called upon to transform financial resources into public
purposes and thus to improve the lot of the individual through distributive justice.
ChecLYaUrProgressl
Note : i) Use the space given below for your answers.
ii) Check your answers with those given at the end of the unit.
1) Explain the meaning of Financial Administration.
2) List any three points of distinction between public and private finance.
3) Why has the study of financial administration become important in recent times?
.
.........................................................................................................
,
a) Equalising Role : Under this role financial administration seeks to demolish the
mequalities of wealth. It seeks, through fiscal policies, to transfer income from the
affluent to the poor.
b) Functional Role : Under normal circumstances the economy cannot function on
its own. Under this role, financial administration seeks to ensure, through taxation,
public expenditure and public debt, and proper functioning of the economy. It
evolves policy instruments to maintain high economic growth and full employment.
C) Activating Role :Under this role financial administration involves the study of such
steps that will facilitate a smooth and rapid flow of investment and its optimal
allocation to iricrease the volume of national income.
d) Stabbing Role : Under this role, the objective of financial administration is the
stabilisation of price level and inflationary trends through fiscal as well as monetary
policies.
e) Participatory Role :According to this view, financial administration involves
formulation and execution of policies for making the state a producer of both public
and private goods with the objective of maximising social welfare of the community.
It also seeks to promote economic development through direct and indirect
participation of the State.
Nature and Seop of Financial
Thus, finmcial administration provides a framework of choices regarding ends and Administration
means which reflect the nature and character of the State and its ideological base as
well as its values. For instance, financial administration of skialist countries differ
from that in democratic countries. Thus,the essence of financial administration
would differ under different socio-political systems depending upon particular.mode
of operation of socio-economic and political forces.
I In the ultimate analysis, there is a need to adopt an integrated approach so that all
the above views are incorporated into the scope of public administration. As an
outcome of such an approach, the following aspects emerge as the core areas of
financial administration.
i) Financial planning
ii) Budgeting
iii) Resource mobilisation
iv) Investment decisions
v) Expenditure control
vi) Accounting, Reparting and Auditing
i) Financial Planning :In a restrictive sense one may consider budgeting as planning
since its basic concern is to facilitate the formulation and adoption of policies and
programmes with a view to achieving the goals of government. But planning, in a
broad sense;includes the concerns in terms of whole range of government policy and
it demands a time frame and a perception of the inter relationships among policies.
Financial Administration : Basin It looks at a policy in the framework of long-term economic consequences. There is
and ObJectivcs a need to coordinate planning and budgeting. The cokept of planning-programming-.
Budgeting System (PPBS) represents an attempt in this direction. Financial
Administration, under this phase, should consider the sources and forms of finance,
forecasting
- expenditure needs, desirable fund flow patterns and so on.
ii), Budgeting :This area is the core of financial administration. It includes
examination and formulation of such important aspects as fiscal policy, equity and
social justice. It also deals with principles and practices associated with refinement of
budgetary system and its operative processes.
iii) Resource M o b h t i o n :Imposition of taxes, collection of rates and taxes etc. are
associated with resource mobilisation effort. Due to the ever increasing commitments
of government, budgetary deficits have become regular feature of government
finance. In this context deficit financing assumes greater importance. But deficit
financing, if used in an unrestrained manner, may prove to be a dangerous problem
for a nation's econgqy for it can cause galloping inflation. Another challenge faced
by administration is tax evasion and growth of parallel economy. Finally public debt
constitutes yet another element of state resources. The proceeds of debt mobilisation
effort should be used only for capital financing. Thus, modem financial administrator
has to be fully conversant with all the dimensions of resource mobilisation efforts.
iv) Investment ~ecisiins:Financial and socio-economic appraisal of capital
expenditure constituteswhat has come to be known as project appraisal. Since massive
investments have been made in the public sector a thorough knowledge of the
concepts, techniques and methodology of project appraisal is indispensable for a
financial administrator.
v) Expenditure control :Finances of the modem governments are becoming quite
inelastic. Almost every government is suffering from resource crunch. Further, the
society cannot be taxed beyond a certain point without doing a great damage to the
economy as a whole. Thus, there is an imperative need for careful utilisation of
resources. Executive control is a process aimed at achieving this ideal. Legislative
control is aimed at the protection of the individual tax payers interest as well as public
interest. There is also the need to ensure the accountability of the executive to the
legislature.
Accounting, Reporting and Auditing :These aspects are designed to aid both the
executive control and legislative control. In India, the Comptroller and Auditor
General (C & AG) and the Indian Audit and Accounts Department over which the
C & AG presides ensure that the accounting and audit functions are performed in
accordance with the provisions of the Constitution.
We shall be discussing in detail about these areas in subsequent blocks of this course.
Check Your Progress 2
Note : i) Use the space given below for your answers.
ii) Check your answers with those given at the end of the unit.
1) What, according to traditional view, is the role of financial administration?
Systems
procedures
KEY WORDS
Comptroller and Auditor General (C & AG) : The C & A G is one of the
Constitutional authorities appointed by the President of India. The C & AG performs
such duties and exercises such powers in relation to the audit of accounts of the union
and of the states and of any other authority or body as may be prescribed by or under
any law made by Parliament.
Deficit Financing :It refers to means of financing the deliberate excess of expenditure
over income through printing of currency notes or through borrowing.
Fiscal Poliq :It is that part of economic policy which is concerned mainly with the
revenues and expenditure of the government. It spells out the application of
taxation, public expenditure and public debt to realise certain public objectives.
Functional Theory : The doctrine which advocated that government should pursue
whatever fiscal measures are necessary to achieve non inflationary, full employment
and economic growth without regard -to budget balancing.
Galloping inflation : It occurs when a persistent inflation gets out of control and
there is decline in value of money. In this situ'ation each increase-in prices becomes
the signal for an increase in wages and costs which again pushes prices up still further.
Great Depression : The World wide depression that started in 1929 and lasted till
1935. It was characterised by low economic activity and mass unemployment.
Laissez Faire : Non-interference policy of the government in economic affairs.
Performance Budget :It is generally understood as a system of presentation of public
expenditure in terms of functions, programmes, performance units viz., activities,
projects etc. reflecting primarily the governmental output and its cost.
Planning-programming-budge* system (PPBS) : It is a technique for optirnising
allocation of funds in the budget by exercising proper choices among. programmes
which compete for limited sources. It emphasises selection of best programmes out
of a number of alternatives available, which could be implemented with a given
quantum of resources.
lhmd.l Administration : ! h e b p o l i t i d theory :This theory as advocated by Wagner laid emphasis on looking
and objecti'vcs at each economic problem in its social and political context and thereby arriving at
an appropriate solution. Wagner, for example, was in favour of using taxation for
reduction of income ineqwlities.
1.9 REFERENCES
Burkhead, Jesse. 1956. Government Budgeting, John Wiley & Sons: NewYork.
Groves, ~ a r o l dM.
; 1958. ~ i k n c i Government,
n~ Fifth Edition, Henry Colt and Co.:
New York.
Lall, G.S. 1976. Public Finance and Financial Administration in India, Kapoor:
New Delhi.
Pinto P. J. J., 1943. System of Financial Administration in India, New Book Company:
Bombay.
Premchand A, 1963. Control of Public 'Expenditure in India, Allied Publishers:
New Delhi.
Sundaram K. P.M., 1974. Indian Public Finance and'Finoncia1Administration, Sultan
Chand & Sons: New Delhi.
Thavaraj, M.J.K., 1978. Financial Administration of India, Sultan Chand & Sons:
New Delhi.
Wattal, P.K., 1962. Parliamentary Financial Control in India, Second Edition,
Minema Book Shbp : Bombay.
2.0 OBJECTIVES
In the previous unit an attempt has been made to familiarise you with various aspects
of the nature, scope and significance of financial administration. Now, in this unit,
an effort i~ made to throw light on cektain other fundamentalsof financial
administiation. After a study of this unit you should be able to :
discuss the objectives of fiscal policies aimed at securing certain social and
economic goals as envisaged in contemporary public policies
describe ways and means as well as appropriate institutional instruments to secure
the above objectives
explain Indian .experience in formulation and execution of fiscal measures through
certain fiscal institutions and processes from time to time
highlight certain trends and their utility in the light of contempbrary challenges
faced .by modern democratic political societies like India; and
discuss the need to comprehend various aspects of financial administration as a
way out to consider contemporary socio-economic problems and the solutions
therefor.
In the early stages of modern age, governments played the role of an umpire to ensure
a free play of market forces. Governments have had a single objective viz., affording
protection to the basic socio-economic framework and the privileged sections and
interest groups from hostile forces threatening the system from inside as well as
outside. In this context, financial administration reflected least public spending asits
basic objective. With the addition of regulatory and welfare functions to the sphere
of government, the functional role of financial administration was articulated in terms
of mobilisation of resources and their productive deployment. It was expected to
achieve the broad objectives spelled out in public policies from time to time. Its aim
was to achieve the objectives o f the government with the maximum possible level of
efficiency at the least expenditure. It is a known fact that there is no universal
agreement about ends of the State. For instance, an autocratic government of
Hitlerian type may piefer "military might" to basic human requirements whereas a
welfare state with a commitment to socio-economic equity may wish to raise the
quality of life of its citizens in preference to arms race. Therefore, one may think that
there cannot be a set of objectives, other than efficiency and economy, which can be
visualised by a student of financial administration. But, it is not impossible to think
in terms of certain common objectives pursued by financial administration all over
the world when one looks at the experiences of the governments throughout the
world; Such an exercise may not facilitate prescription of a set of objectives by a
student of financial administration, but it will certainly help hirnlher to have a view
of hisher own as to what the objectives ought to be.
In this unit, we will discuss the objectives and principles of Financial Administration. Objectives and Rindpks d
We shall also trace the evolution of financial administration in India and also highlight Flnaneial Administration
some of the emerging trends.
2) What are the fundamental concerns -of financial administration which transcend
politico-economic compulsions?
This dictum does not mean centralised decision making and decentralised
implementation. Experiences of developing countries have exposed the inadequacy
of centralised decision making. Now, the need of the hour became centralised
direction and decenGalised decision making and decision implementation. The
concept of administrative financial control has given way to the concept of
management of results. Under this changed context, this principle should be taken
to mean centralised guidance for facilitating decentralised decision making with a
view to securing optimum production as well as optimum utility. The concept of
,national planning is a good example.
5) The principle of stability and balance
It is a known fact that the financial administration is characterised by technical
expertise and hence cannot be handled by unskilled and non-trained personnel. This
character poses serious problems when there is a loss of specific trained personnel.
Therefore, this principle calls upon financial organisations to develop capacity to
withstand losses of specific trained personnel without serious corisequences to
effectiveness,and efficiency. For this purpose, there is need for effective-manpower
planning together with a good programme for human resource development.
6) The principle'of simplicity and flexibility
In a democratic era electorate functions as the fountain of all authority. All other
democratic institutions, including parliament, derive their authority from electorate.
Therefore, it is very essential that the financial system and its procedures should be
simplified in such a mannepo as to become intelligible to the layman. According to
P.J:J. Pinto, if this prin&ple is implemented properly, it can economise the costs.
The principle of flexibility implies that the financial organisation should develop
capacity to adjust itself. to fluctuations on work flows, human compositions and
physical facilities.
7) The principle of conduct, discipline and regularity
The principle of conduct implies that the officials of public financial organisations
should act ethically and set high ethical standards and styles to the people. Income
tax officials, for instance, could be very effective in preventing tax evasion by s e t t i ~ g
ethical examples themselves.
The principle of discipline implies that the objectives, rules and regulations, the
policies, procedures and programmes must be honoured by each participant of public
financial organisation. No organisation can function effectively without firm financial
discipline. The practising administrators are prone to use imposed discipline which
may not yield desirable outcomes. What is needed is voluntary or self-discipline.
The principle of regularity implies that no public organisation, including financial
organisation, can afford to function at intervals. We should bear it in mind that the
administrative task is a continuous process.
8) The principle of Public Trust and Accountability
Financial administration collects and disburses public funds as a public trust. But, it
is quite vulnerable and can lead to misuse of these funds for personal interest.
Financial administration has therefore to be held publicly answerable for proper use
.. ~f funds at several levels such as political, legal, administrative, organisational,
professional, moral and aspirational. Here accountability implies answerability for
me's responsibility and for trust reposed in an official.
.16)
x*
Non-bureaucratic delivery of public goods and services
Following public choice theorists, the government is thinking in termsbf providing
public goods and services competitively to avoid the pitfalls of public monopoly. The
government, for instance, is seriously thinking in terms of involving private sector in
power generation and distribution, electronic media and telecommunications, roads
etc.
.
7) Focus on decentralised responsibility for financing development
,
plans
Union Government has had the responsibility for plan formulation as well as plan
financing The state governments could execute centrally sponsored schemes rather
than the schemes supported by their budgetary provisions. This tendency on the part
of the State led to a lack of concern for resource mobilisation. This syndrome is
evident from increasing emphasis of the state governments on populist measures. As
a back-up to economic reforms the Union Government has veered round to the
concept of "indicative planning". This changed outlook pervades the formulation of
the Eighth Five Year Plan. The Union Government, is now promoting cooperativ
federalism and is therefore, seelcing an active role for the state government in
resource mabilisation.
8) Towards deregulation and liberalisation
Union Government m an effort to provide full freedom to market mechanism so as
to maximise productive potential of enterprising business people is moving towards
a free market economy. Industrial policy has been suitably amended to accodpodate
genuine requirements of private sector and foreign direct investment. We shall be
discussing the important features of this irl Unit 3 of this block. Similar changes have
been made in Trade Policy and Commercial policy.
There is a growing feeling that the inequalities of income and wealth may get
accentuated and that the poor and weaker sections of society may be left to tend for
themselves. This unfortunate trend can be largely redressed through increased
expenditure on social services and rural development programmes. There is already
evidence that the government is taking policy initiatives like strengthening of public
distribution system and other means to ensure that growth is not achieved at the cost Objectives and Principles of
Financial AdminlsCration
of equity.
To sum up, these new trends are intended to liberate market forces from bureaucratic
control. These trends were found to be quite in conformity with the requirements of
underdeveloped countries. In fact, some countries have registered astonishing
breakthrough with similar policy packages. Therefore, the government did not face
any major resistance against its approach. A major failure though expected, has been
the inability of the government to contain price rise. The government is seeking a
period of two to three years to show concrete outcomes. One has to wait and see if
the new policies can pull the country out of economic stagnation and the price paid .
for such is also affordable. ,
ii) Check your answers with those givkn at the end of the unit.
1) Outline the emerging trends in financial administration of 1ndia.
2) What are the budgetary concepts which have found their way into Indian
economic reforms package?
.3
W ~ n e of
Dlwanl Rights :The East India Compartyl dcuting the right to collect taxes in Bengal,
Bihar and Orissa in 1765.
Dyarchy :It is the two level governmeqti~troducedat the provincial level under the
Montague-Chelmsford Act of 1919. It &ded the whole administration between the
'reserved' subjects (controlled by couMlors) and 'transferred' subjects (controlled
by the ministers).
Factors of Production : The resouqes hjuired to produce a commodity i.e. land,
labour and capital.
Free Market Economy : An economy Which is not planned, controlled or regulated
by the government. It is a competiriv&eebnomy. The factors of production are
privately owned and production takes &ace at the initiative of the private enterprise.
GovernmGeneralof India-ln-Council :*fhe system of governance in India by the East
India Company was basically conducted by the Council alongwith the Governor-
General.
Indicative Plrrlrning : It is planning byA&dication of desirable targets rather than by
compulsion. 2 ,
,
3.0 OBJECTIVES
After reading this unit you should be able to :
explain the basic concepts of mixed economy, capitalism, socialism and the salient
features of mixed economy
trace the evolution of mixed economy in India by examining various Industrial
Policy Resolutions
e describe the respective roles of private sector and the public sector in the Indian
economy; and
discuss recent policy changes introduced in India and an appraisal 'of their
significance.
3.1 INTRODUCTION
: India's development experience is inextricably linked with India's decision to opt for
a mixed economy in the beginning of her own planning process. There neither was
nor is even now a consensus among social scientists whether the choice of the mixed
' economy concept was right for India. On the one hand, the heavy industry bias,
insufficient resource allocation, noncompetitive nature of Indian economy in the
global context, (high cost economy and'shackling of the growth impulses) are all
traced to this decision to opt for mixed economy. It implied a significant degree of
government intervention and control. On the other hand, the left-wing economists
have viewed the adoption of mixed economy framework as being "little more than a
deGce for legitimising the rule of the capital in direct collaboration with the State.
They seem to regard it as axiomatic that a mixed economy represents nothing more
than a compromise weighted heavily in favour of the vested interests." It has
nevertheless to be conceded that market forces left to themselves cannof offer a
solution to the problem of poverty, when millions of people live so close to
subsistence and a large number below subsistence level. Also, given the way India's
culture has evolved, a centrally planned economy with the State steering the social
and economic change is an impossible model for the country. Pursuit of a mixed
/ economy, therefore, has been the only feasible proposition.
What has been, however, suitable in the fifties is not necessarily suitable in the
nineties. The politico-economic map of the world, particularly of the socialist bloc,
has been redrawn and can hardly be recognised. Minimal State cannot be the answer
in view of the heterogeneity of the coubtry and the vast magnitude of poverty. As
we witness the poor performance of the public sector it a + p that the pervasive
I and intrusive role of thestate has also lost-its relevance. Thus,'let us examine the'
Financlal Administration : Basics
and Objectlver MIXED ECONOMY - CONCEPT AND SALIENT
FEATURES
Mixed economy implies demarcation and harmonisation of the public and private
sectors. In it, free functioning of the market mechanism is not permitted and the
government intervenes or regulates the private sector in such a way that the two
sectors become mutually re-inforcing. A mixed economy represents an achievable
balance between individual initiative and social goals. Planning and market
mechanisms are so adjusted that each is used for realising the objectives of the
'economy to which it is most suited. There is a commitment on the part of both the
sectors to national objectives and priorities.
Ownership of sectors is used by some to classify them. A system comprising
cooperative organisations would be called a cooperative commonwealth. A system of
joint sector organisations gives another type of mixed economy. A system in whict
both publi~sector and private sectors are present is the mixed economy of the
conventional type. This mixed economy could be ad-hoc or a systematic type
depending upon the extent of coverage by the public sector of core sector of the
economy. The other consideration would be the extent to which the two sectors have
been integrated and harmonised with the policy objectives of the economy as a whole.
It would be an economy that shows concern for the welfare objectives of the weaker
sections through a combination of public distribution system, poverty alleviation
programmes as also the production priorities based 'on a market economy. It could
also be an economy that emphasises the social objectives of equity, employment,
self-reliance, etc. There would be a varying degree of the mix of planning and market
economy in each type of mixed ewnomy.
At times, it is held that every economy is a mixed economy and that the concept of
mixed economy is neither precise nor worthwhile. It has, however, to be appreciated
that the concepts of planned economy and market economy have definite ideological
and operational profiles. The concept of mixed economy represents a middle position
between these two extrpmes. This concept is flexible and has its own means and
methods of approaching economic, political and social issues. To achieve clarity in
the understanding of the concept of mixed economy, let us discuss the meaning and
characteristics of Capitalism, Socialism.
Capltalism
Capitalism has been defined as an economic system stressing individual initiative with
a central role for a market economy, the profit motive and ownership of means of
production,by private individuals and corporations. Under capitalism, all means of
production such as farms, factories, mines, transport are owned and controlled by
private individuals and firms. Those who own these means of production are free to
use them as they like in order to earn private profit. The State or government takes
least part in the economic activities of the people. The government looks after only
such matters as defence, foreign affairs, currency and coinage and some important
civil works such as the construction of roads and bridges because private individuals
may not find it profitable to undertake such works. Adam Smith was of the opinion
that interests of individuals and thpse of the society coincide. The government,
therefore, has no role in economic activities. In fact, the State was inherently
incapable of undertaking such activities. State undertaking would mean wastage of
society's resources. Things should be allowed to take their own llrse and there was,
+
.
Capitalism has an ugly face also -it divides t&wqiety into those who are vulgarly
rich and indulge in ostentatious consumption, .-those who are the wretched of the
earth and do not have even two square me&*^ day. The incentive system is also
vitiated by the inequalities of income which ravated. Consumers' sovereignty
is a myth. In fact large corporation controls et which it is supposed to serve
and "even bend the consumers to its sts which capitalism imposes
on the society are in the form of infl ent, and cyclical fluctuations.
Prof. Galbraith sums up the ineffectiveness m i t a l i s m thus : "There ismuch that
the market can usefully encourage and acca- - as it cannot put a man into
space so it cannot bring quickly into existencqi&bl industry where there was little
or no steel making capacity before. Nor can it-ly create an integrated industrial
plant. Above all no one can be certain that it'* do so in countries where
development has lagged and where there is n4 only need for development but an
urgent demand that it should occur promptly. 30trust to the market is to t.ake an
unacceptable risk that nothing, or too little, w@ happen."
'I
Schedule B : There were about a dozen industries in the list, where the State might
establish new units or existing units might be progressively nationalised. In these
industries, the private sector was guaranteed plenty of opportunity to develop and
expand. It included the following industries : Other mining industries, aluminium and
other non-ferrous metals not included in Schedule A , machine tools, ferro alloys and
steel tools, chemicals, antibiotics and other essential drugs, synthetic rubber, pulp,
road and sea transport.
Schedule C :Industries in this Schedule consisting of the rest of the industries, not
included in Schedules A and B, would be in the private sector and would be subject
to the social and economic policy of the government. The Industries (Development
and Regulation) Act of 1951 and other relevant laws would apply to these industries.
Among other things, the resolution emphasised that fair and non-discriminatory
treatment would be given t~ private sector industries and their development,
encouraged by developing transport facilities and by providing financial assistance.
The regulation recognised that the private sector by itself could not bring about rapid
industrialisation of the country. It, therefore, provided vital and expanding scope for
public sector industries. At the same time, private sector was assured of an important
place in the industrial structure of the country. The resolution also acknowledged the
important role of village, cottage and small scale industries.
Flnenclei Admlnlstretion : Beslcs The resolution accorded a prominent role to the public sector. The apprehensions of
end ObJectlves the private sector that the public sector would develop at their cost did not turn out
to be correct and private sector found ample scope for its expansion.
Industrlpl Pollcy Reeolutlon, 1977
The new Industrial Policy of 1977 was very critical of the 1956 Resolution on tht
ground that "Unemployment has increased, rural-urban disparities have widened and
the rate of real investment has stagnated. The growth of industrial output has been
no more than three to four per cent per annum on the average. The incidence of
industrial sickness has become widespread and some of the major industries are worst
affected. The pattern of industrial costs and prices has tended to be distorted and
dispersal of industrial activity away from the urban concentration has been very
slow". Other points of criticism were that international giant indust## concerns had
penetrated the protected Indian market and monopolistic power of the large business
houses had increased. The new policy focused on the development of small scale
sector, cottage and household industries and the tiny sector. It further provided for
using provisions of the Monopolies and Restrictive Trade Practices Act against
expansion of larger industrial houses. The public sector was to be used for providing
strategic goods of basic nature gnd also for maintaining supplies of essential goods.
In areas where foreign collaboration was not required because of the availability of
indigenous technical know-how, such collaboration agreementswere not be renewed.
Apart from giving greater importance to village and small scale sector and at the same
time instilling a se'nse of fear among large industrial houses, the new policy did not
lead to much achievements.
IadurtrW Pdley of 1 m
Outlining the Industrial Policy of 1980, it was stated, "The Industrial Policy ,
...
announcement of 1956 reflects the value system of our country anqhas shown
conclusively the merit of constructive flexibility, In terms of this resolutibn, the task
of raising the pillars of economic infrastructure in the country was entrusted to the
public sector for reasons of its greater reliability; for the very large investments
required and the longer gestation period of the projects for economic development,
The 1956 Resolution, therefore, forms the basis of this statement? The policy
accorded priority to optimum utilisation of installed capacity, balanced regional
development, agro-baaed industrieg, export-oriented industries and promoting
"economic federalism" by equitable spreading of investment over small but growing
industrial units in urban as well as rural areas.
I . r
The following table gives us an idea of the growth of public sector enterprises in India :
Aeoa 1.4.1951 29 5
Aeon 1.4.61 948 47
These are the Central Government public sector enterprises. In addition, there are
a large number of various State Government public enterprises like irrigation
projects, State Electricity Boards, State Road Transport Corporations, State
Financial Corporations etc. These enterprises also exclude departmental undertakings
like railways. The enterprises also included in the table above, large as they are -
account for only about half of the gross capital formation of all public enterprises.
Major contributiorl of the public sector has been through the development of new
sophisticated industries, and giving a more mass welfare bias to the existing services.
New skills were created and professional management in industry which was hitherto
maidy confined to multi-nationals, became widespread. Ever ~ i n c ethe third plan,
the public sector investment largely accounts for somewhat more than half the total
plan investment. Apart from the normal government activities and departmental
undertakings, basic and heavy industries like steel, heavy electrical and nonelectrical
machinery, machine tools, etc., were developed in the public sector. These were
industries which would take a long time to fructify and were risky. It was felt that,
by and large, private industry would not be attracted to them or would only be
prepared to come on terms which would not be acceptable to the nation. Existing
units in the private sector were left untouched with the exception of banking,
insurance, oil, coal and power. Many of the sick units providing employment on a
large scale were also nationalised.
Financial performance of public sector enterprises has been quite disappointing.
Excluding the oil sector, which is highly profitable, the other public sector enterprises
have been incurring net losses or making only a marginal profit. Even if the oil
industry is included, the overall ratio of net profits after tax as a percentage of net
worth are just about 4.5 per cent in 1990-91 as against 5.4 per cent in 1989-90. The
sectors which have been heavily losing include fertilisers, heavy engineering,
consumer goods, urban transportation, coal, textiles, and contract and construction
Some of the factors which are responsible for the poor performance of the public
sector are as follows :
i) Administered pricing policy of the government in respect of urban
transportation, coal, fertiliser industries, etc. is fully responsible for non-recovery
even of costs of production. The concerned public enterprises can hardly be
called inefficient, even though they are unprofitable.
ii) The nature of a large number of enterprises is such that they have long gestation
periods and quite often there are heavy cost overruns because of the gestation
beriods and intervening inflation.
iii) Excessive manpower recruitment due to political decisions. Mixed Econom:
Indian experience has shown that the pursuit of a mixed economy framework in a
developing economy is a feasible proposition. It can lead to a modest rate of growth
and also substantial growth of productive capacify in key sectors of the economy.
Values of a social democracy have been assiduously nurtured and significant results
have been achieved in reducing inequalities through various poverty alleviation
programmes. Recent changes in the direction of economic policy have, however, led
many'to doubt whether the Nehruvian model of mixed economy and all that went
with it, is still in place. If mixed economy is viewed as a path which avoids the rigours
of both capitalism and socialism, then mixed economy has served the country well
and may continue to do so in future. In spite of lib=ralisiifion o r deregulation, we
have not moved to a stateof market economy. All that has happgned js that we
have started questioning and even demolishing the complex regulatory frameworks
administered by an overloaded bureaucracy which failed to orient itself to the task
of development administration. Controls and regulatory mechanisms never formed
part of the core of development strategy, being themselves largely an inheritance of
the war economy which the British Government had clamped on the country only to
maximise procurement for military consumption. Removal of these controls will only
make the economy more vibrant and dynamic without losing sight of the
socio-economic perspectives it has set for itself.
Cbeck Your Proryess 2
Note : i) u s e the space given below for your answers.
ii) Check your answers with those given at the end of the unit.
1) What are the objectives of the public sector in India?
Mixed Economy
2) Briefly describe the factor6 responsible for the poor performance of the public
sector.
.........................................................................................................
...........................................................................................................
.........................................................................................................
3) Enumerate the key provisions of the New Industrial Policy of 1991.
..........................................................................................................
.........................................................................................................
.........................................................................................................
4) What other steps have been taken to deregulate the economy?
LET US SUM UP
h e d economy implies demarcation and harmonisation of she public and private
sectors. In it free functioning of the market mechanism is not permitted and the
government intervenes or regulates the private sector in such a way that the two
sectors become mutually reinforcing. There is a commitment on the part of both the
sectors to national objectives and priorities. It is a middle path between the two
extreme systems of capitalism and socialism.
Capitalism has been defined as an economic system stressing individual initiative for
a market ewnomy, the profit motive and ownership of means of production by
private individuals and corporations. On the other hand, socialism is an economic
organisation of society in which the material means of production are owned by the
whole community to a general plan, all members being entitled to benefit from the
results of such socialised planned production on the basis of equal rights.
In India, the concept of mixed ewnomy was evolved so that both the private and
public sectors could contribute to the process of economic growth. The Industrial
Policy Resolution of 1956 gave a definite shape to it by clearly demarcating the areas
in which each sector would operate. The two instruments of policy were the Industries
(Development & Regulation) Act of.1951 and the Companies Act of 1956. These two
Acts conferred on the government through licensing procedure, the power of
regulating location, production and expansion of major industries in India. The
Industrial Policy Resolutions of 1977 and 1980 further refined the operational
framework of mixed ewnomy in India. Private sector in India contributes nearly
80 per cent of the national income whereas the public sector contributes the balance
20 per cent. The organised private sector is modernised, capital-intensive and has
access to modem financial services. Over the years, however, the private sector, has
become a high cost sector, and hence non-comwtitive with the international sector,
F l n a c u Ad-tration : Basics The public sector was supposed to have control over the commanding heights of the
and Objectives economy. Its objectives included helping the country in the rapid economic growth
and industrialisation, generating resources for further investment, creating
employment opportunities and promoting social welfare through more equitable
income distribution, etc. It has grown from 5 enterprises in 1950-51to 236 in 1990-91
and its investment has gone up from Rs. 5 crore in 1950-51to over Rs. l(IOOOO crore
in 1990-91. The performance of the public sector has, however, been quiie
disappointing. Among the many factor's responsible for this are political interference,
administered price policy, excessive manpower and under-utilisation of capacity.
The new Industrial Policy was announced on 24th July, 1991 which sought to
delicense and deregulate the economy in many ways. Areas reserved for the pubfic
sector have been narrowed down. Several other measures relating to liberalising trade
and foreign investment have also been taken. With the dismantling of artificial
controls, it is expected that the economy will become internationally competitive, and
economically efficient. The social dimensions of the mixed economy continue to be
given a pride of place in the emerging scenario.
3.8 REFERENCES
Wiles, P. J.D. 1975. Economic Institutions Compared, Basil Black Well : Oxford.
Namjoshi, M.V. 1984. The Mixed Economy, Himalaya: Bombay.
Jha, L.K. 1980. Economic Strategies for the 1980s, Allied : New Delhi.
1QCiR. Asian Drama. Pennuin : London.
Mixed Economy
3.9 ANSWERS TO CHECK YOUR PROGRESS
EXERCISES
Check Your Progress 1
1) Your answer should include the following points :
Balance between the yarket economy and the planning mechanism
A clear demarcation d boundaries of the public sector and the private sector
Objectives of equity, social welfare, employment etc.
The government intervenes and regulates the private sector to secure
adherence to national objectives and priorities
2) Your. answer should include the following points :
The establishment of a socialistic pattern of Society, giving importance to the
expansion of public sector
Classification. of industries into three categories :
Schedule A : 17 industries reserved for the public sector
Schedule B : About a dozen industries where the State could establish new
units or nationalise the existing ones
Schedule C : Rest of the industries to be in the private sector.
Private sector assured of an important role in the industrial structure of the
country.
Check Your Progress 2
1) Your answer should include the following points :
Objectives of the public sector include,
helping the country in the rapid economic development and industrialisation
generating resources for further development
promoting balanced regional development
creating employment opportunities, and
promoting social welfare and self-reliance.
Your answer should include the following points :
Among the factors responsible for the poor performance of theSpublicsector are :
Unrealistic pricing .policy
Political interference in business decision-making.
Excessive manpower
Under utilisation of capacities
i Government controls in wage & income policies, personnel policies,
investment decisions etc.
3) Your answer should include the following points :
Abolition of industrial licensing
Dilution of the MRTP Act
o n l y eight areas reserved for public sector as against seventeen areas
reserved earlier
Establishment of a National Renewal Fund.
4) Your answer should include the following points :
The limit of foreign equity holdings raised in priority industries
Expeditious clearance of foreign investment proposals in non-priority
industries
Partial convertibility of rupee
Government control over capital issues withdrawn.
UNIT 4 CENTRE-STATE FINANCIAL
RELATIONS - I
Structure
4.0' Objectives
4.1 Introduction
4.2 Federalism - Meaning
4.3 Basic. Features of Federalism
4.4 Principles of Fiscal Federalism
4.5 Evolution of Fiscal Federalism in India
4.6 Let Us Sum Up
4.7 Key Words
4.8 References
4.9 Answers to Check Your Progress Exercises
4.1 INTRODUCTION
?he classic concept of federalism which envisaged two parallel governments of
coordinate jurisdiction, operating in water-tight compartments is nowhere a
functional reality now. Federalism is not a static paradigm. Federalism has come to
be understood as a dynamic process of cooperation and shared action between two
or more levels of government, with increasing interdependence. "The framers of the
Indian Constitution took due note of these changing concepts and functional realities.
Avoiding a dogmatic approach, they fashioned a suigeneries system of two-tier polity
in which the predominant strength of the ~ h i o ' nis blended with the essence of
cooperative federalisni. Several features and provisions of the Constitution appear to
have been'deliberately designed to institutionalise the concept of cooperation."
The pri;nary lesson of India's history is that, in this vast country, only that polity or
system can endure and protect its unity, integrity and sovereignty against external
aggression and internal disruption, which ensures a strong centre with paramount
powers, accommodating at the same time, its traditional diversities. Another feature
of India's Constitutional history that stands out like a sore thumb is the reality that
"too centralised an administration is incompatible with the size and diversity of the
Econo~nicDeterminants
Decentralisation of powers and resources through federalism is regarded as a better
solution to achieve economic take-off, optimal resource use, removal of regional
economic disparities and strengthening of bargaining power in the global market. In
developing countries, it is possible to enhance allocation of resources on health,
education, poverty alleviation and social services. The objectives of equity and
balanced regional development may, however, not be served at least in the short run.
Theoretically, with the breaking down of barriers to trade and free movement of
labour and capital being allowed, the factors of production will move to regions where Centre-State Financial Relations-1
returns are the highest. In the USA, however, the territorial expansion of the
federation intensified the clash of economic interests between the Northern and the
Southern States. The South feared a situation of permanent economic inferionty to
the North and hence the attempt to secede from the federation. The formation of the
federation in the first place was prompted by the desire to protect their farming,
trading and the need for integrated market serving the primary interests of the rising
industrial and commercial classes. The Commonwealth of Australia was a later
creation through a similar process of aggregation and integration promoted by more
or less similar considerations. The dominance of maritime provinces has also
accounted for a strong centre in Canada. In the case of India, the extreme
centralisation which characterised Indian administration under the British rule was
designed to subserve the British economic interests. But centralising features were
gradually modified in response to the nationalist struggle.
d."
be o occasion for the central government to encroach upon jurisdiction of the unit
go ernments and vice-versa. In times of national emergencies, however, the
c nstituent units shed some of their political and financial jurisdiction in favour of
the central government for achieving national objectives. Federal Constitutions
usually contain specific provisions to cope with such contingencies.
~fficiency
The system of distribution of functions should conform to the requirements of
efficiency and economy. "No matter how well intentioned a scheme may be or how
completely it may harrnonise with the abstract principles of justice, if the tax does
not work administratively, it is doomed to failure". Two factors determine the
effectiveness of different taxes, namely, nature of the tax and the character of
administration. A land tax for instance, may be expected to be administered best by
local authorities because "it is, after all, the local assessors who may be presumed to
possess the most exact knowledge of the local conditions upon which the value of the
land depends". One of the reasons for the formation of a federation is that a
government atathefederal level will be efficient for the nation as a whole: The division
of sources is, therefore, based on the principle of relative interest and efficiency.
Taxes which have an inter-state base, like customs, income and wealth tax are
assigned to the federal government and those which have a local base, like sales tax
and entertainment tax, are assigned t o the states. Costs of collection of taxes, the
feasibility of levying taxes at the nationwide level rather than at the local level are i
important consideratiohs in the allocation of powers and functions.
Equity
Fiscal federation is viewed within the framework of welfare economics. Equitable
distribution of wealth and income of the community are the proper concerns of a
welfare state. Experts argue that the entire system of federal and state taxation and
expenditure should be so framed as to impose equal burdens and confer equal
benefits upon similarly placed persons irrespective of their residence. From the point
of view of the nation, there is a distinct advantage in taxing the richer states more
and spending that revenue in poorer states since the sacrifice in extra taxation in
richer states is less than the benefit that will be derived if that money were spent in
poorer states. The ideal is to maximise national benefit from the state and federal
expenditure. This would necessitate a reduction of welfare generating expenditure in
richer states and an increase in such expenditure in poorer states. Federal fiscal
operations have an equalising role in respect of tax bukdens and benefits from public
expenditure as between the affluent and less fortunate states.
Distributive aspects of income and wealth are best performed by the central
government. If redistribution policy is left to the state governments regional
disparities may be perpetuated. Rich may leave the region where redistribution
measures are more egalitarian, while the poor will move to such regions. Progressive
income tax which is an important redistribution measure must be uniform throughout
the country. This is possible only when the tax is entrusted to the national
government.
Centre-State Finandd Relations-l
Equalisation Transfers
It does not usually happen that the revenues appropriate to federal and state
exploitation yield exactly the sums of money required for performing their respective
functions.
In most federations, elastic sources of revenue are in the hands of the federal
government which has surplus resources. Through various means, federal
governments have further widened their sources of revenues. The resulting financial
imbalance between the federal and unit governments necessitates transfer of revenue
to the unit governments in order to enable them to perform their constitutional
functions. In fact, there has been a major extension in the functions of both the levels
of governments. While the federal governments have been able to mount the
requisite mobilisation efforts, the state governments, mostly with inelastic Sources of
revenue, which cannot be stretched beyond a certain extent have been hamstrung in
their efforts to meet these expanding demanqs, particularly those in the social services
sector. Hence the need for fiscal equalisation.
Fiscal equalisation has been defined as a systematic process of inter governmental
financial transfers directed towards equalisation of the budget capacity or economic
performance. A fiscal equalisation is intended to make it possible for the
governments to provide a standard range and quality of services for their citizens.
The fiscal capacity of a government is its relative revenue raising capacity on the one
hand, and its relative cost of providing a standard range and quality of services, on
the other. Fiscal performance is defined as a government's fiscal effort with reference
to its revenue capacity. In a programme of fiscal capacity equalisation, governments
are enabled to provide services on a standard scale while imposing standard burdens
in the form of taxes and other charges. Fiscal capacity equalisation concept has meant
devolution of responsibility and decentralisation in the decision making process. It is
in fact the federalist answer to the problem of regional inequality.
The scheme also envisaged grants-in-aid from the Centre to the provinces in need of
assistance as approved by the former. The Government of India Act, 1935, laid
foundations for a system of elaborate but flexible financial arrangements betwenenthe
centre and the provinces.
The long history of the evolution of public finance in India shows very complex
factors at work. However, one clear discernible trend is that while it is wholly possible
to divide the taxation powers and allocate resources, it is difficult to establish a
balance between need and resources. The various stages of evolution helped confirm
the maxims :
i) that no decentraiised government can be established without allocating to it
sufficient financial powers; and '
ii) that the central government is the appropriate authority to levy a tax where
uniform rate is important and locale is not a guide to its true incidence.
4.8 REFERENCES
'rhavaraj, M.J.K. 1978. Financial Administration of India, Sultan Chand & Sons:
New Delhi.
Sinha, R.K. 1987. Fiscal Federation in India, Sterling: New Delhi.
Thimrnaiah G. & H. Rao, 1986. Finance Commission and Centre State Relations,
Ashish: New Delhi.
Commission on Cent1 2 State Relations (Sarkaria Commission) Report, 1988.
Manager, Government of India Publications: New Delhi.
The Ninth Finance Commission, Second Report (1990-95), 1990. Manager,
Government of India Publications: New Delhi.
5.1 INTRODUCTION
Federations, old and new, are characterised by a clear division of functions and
resources between the federal government and the unit governments. Framers of the
Indian Constitution were acutely aware of the conflicts and problems which were
faced by the old federation's in the sphere of financial relations. They also had the
additional benefit of the pre-existing financial system embodied in the Government
of India Act, 1935. The Constitution envisages that fiscal resources would be
transferred to the States on the recommendations of.the Finance Commission. The
role of the Finance Commission has, however, come to be limited mainly to
channe~isin~ of revenue transfers. The capital resources for planned development are.
now tra~sferredon the recommendations of the Planning Commission. The National
Development Council, members of which, among others, include Chief Ministers of
all States, reviews the working of the national plans, considers questions of national
developmental policy and recommends measures for the implementation of the
objectives and targets set out for the national plans. These institutions are expected
to play a very effective role as adequate forum of consultation and cooperation
between the states and union, but within a centralised framework.
Apart from the union and state lists, there is a third list known as the concurrent list.
Functions of an inter-state nature, such as commercial and industrial monopolies,
labour disputes, social legislation, social security and.economic and social planning
have been placed under the concurrent legislative powers of the central and state
governments. In the event of a clash between. the laws of the central and state
governments over a concurrent area, the former i.e. the central law prevails.
The Constitution describes India as a 'Union of States'. A motion to designate India
as a 'Federation of States' was rejected by the Constituent Assembly. Dr. B.R.
Ambedkar put it very succinctly thus;
". .. though India was to be a federation, the federation was not the result of an .
agreement by the States to join in a federation and that the federation not the
result of an agreement. no State has the right to secede from it. The federation
is a Union because it is indestructible. Though the country and the people may
be divided into different States for convenience of administration, the country is
one integral whole, its people a single people living under a single imperium
derived from a single source. The Americans had to wage a civil war to establish
that the States have no right of secession and that their federation was
indestructible ."
The Drafting Committee thought that it was better towmake it clear at the outset
rather than to leave to speculation or to dispute.
Financial Powers
In effecting a division of resources, the Constitution provides for a strong centre. The
Constitution ensures the supremacy of the action of the Union Government over the
fairly comprehensive Union list as also over concurrent jurisdiction. Allocation of the
heads of taxation between the union and the states is based on ;he broad principle
that taxes which are location-specific and relate to subjects of local co<sumption have
been assigned to the states.
.
Those taxes like for example Income tax which are of inter-state significance and
where the place of residence is not a correct guide to the true incidence of tax have
been vested in the union. This clear-cut division of heads of taxation between the
union and the states has minimised the scope for conflicts and litigation between them.
The taxes over which the union has legislative jurisdiction can be classified as follows :
a) Taxes which are to be levied and collected by the Union and the entire proceeds
therefrom are to be retained by it. These include corpcration tax and customs
duties.
b) Taxes which are levied and collected by the Union but proceeds are shared with
the States. These are income tax, and excise duties.
c) Taxes which are levied by the Union but collected and retained by the States.
These are estate duties and terminal taxes on goods and services.
d) Taxes which are levied by the Union but collected and retained by the States.
These are excise duties on medicinal and toilet preparations (containing alcohol),
opium, etc.
In achuon, there are exclusively state taxes, i.e., taxes levied and collected by the
states and appropriated by them. This category includes land revenue, taxes on
. .~ . . - - - . .-..
~ - .-
FLnancid Administration : Basics Article 286 of the Constitution forbids taxation by states of
and Objeftlves
a) imports into or exports from the tercitory of India;
b) Inter-state trade; and
c) sale of goods dec1ared.b~the Parliament by law to be essential for the life of the
community.
The property of the union is exempt from state taxation. The property and income
of the states are exempt from the union taxation.
In addition to the provisions for tax-sharing, Article 275 of the Constitution provides
for both general purpose and specific grants. However, it has been left to the
Parliament to decide which states are in need of grant assistance and to what extent
subject to the recommendations of the Finance Commission.
The borrowing powers of the central and state governments are regulated by Articles
292 and 293 of the Constitution. The central government can borrow on the security
of the Consolidated Fund of' India within and outside the country subject to the limits,
if any, specified by the Parliament. The state governments can borrow generally only
within the temtory of India with the consent of the central government. The central
government may also give loans to the state governments, subject to such conditions
as are laid down in a law of Parliament.
If the President of India is satisfied that a situation has arisen where the financial
stability or credit of India or any part of the temtory thereof is threatened, the
President may declare financial emergency under Article 360 of the Constitution. In
these abnormal and emergent circumstances, both collection and distribution of
revenues in state governments are made by the central government or state
governments as decided by the Parliament.
Allocation of financial powers, and resources between the centre and the states, is
indeed the most vital and yet the most difficult task. The revenues of the federations
have undoubtedly. been growing. In some federations like the United States of
America, where the federation and the states have concurrent taxation powers, there
has been a lot of litigation which is inherent in the exercise of overlapping powers.
In Australia and Canada, negotiations and agreements played an important part in
determining the shares in the proceeds of'taxes. In such situations, it is political
expediency rather than time-honoured conventions which come handy in resolving
conflicts. With regard to allocation of financial resources between the centre and the
states as said earlier there are constitutional provisions that :
i) the states are entitled to a significant share in federal taxes;
ii) the proceeds of certain taxes levied by the centre are totally assigned to the states;
and
iii) there is a system of grants-in-aid to the states.
One criticism that is often voiced regarding the allocation of financial resources
between the centre and the states in India is that elastic and substantial sources of
revenue have been assigned to the centre whereas the states, which have been
entrusted with important developmental and welfare functions, have been entrusted
with inelastic and inadequate sources of revenue.
The Finance Commission is a quasi-judicial body and it acts independent of the centre
and the states. The specific terms of reference of each Finance Commission are
drafted by the Ministry of Finance at the Centre. The state governments are not
consulted in the matter. Practical difficulties in working out a consensus approach,
amongst different states at times ruled by different political parties with different
viewpoints, seem to have discouraged consultations with the state governments.
In the absence of a clearly specified and constitutionally recognised institutional
mechanism for revenue-sharing between .the federal and state governments in some
of the important federations, numerous adjustments had to be resorted to. In the first
place, because of concurrent taxation powers in federations like USA, Australia and
Canada, "which level uses what kind of tax and what extent has been decided more
by custom and negotiation, included in statute, or agreement, than by Constitutional
provision". In USA, at least, the tax system which dame to be developed over the
years is described to be uncoordinated and overlapping. The other federations have
faced similar or worse problems.
The Finance Commission in India on the other hand, because of its constitutional
status constitutes a unique arrangement. Because of this status and the fact of being
an expert body, the devolution of resources i.e. tax-sharing and grants-in-aid has been
removed from the arena of political bargaining. Even though the Commission is an
advisory body, its recommendations, along with the action taken thereon, have to be
placed before the Parliament.
According to the Constitution, the Finance Commission should consist of a Chairman
and four other members. According to the Finance Act, 1951, the Chairman shall be
a person with experience in public affairs. The four members should have been or be
qualified to be appointed as Judge! of the High Court, or should have specialised
knowledge of economics, financial matters or finance and accounts of the
government.
The constitutional status accorded to it. and its functioning as a semi-judicial expert
body has earned for the Finance Commission high regard of the Union and the States.
The Approach
la Ind~a.so far ten Finance Commissions have been set up and thev adopted a
common approach with regard to fis'cal transfers from centre to states. Some uniform
principles or considerations have been kept in view by the Finance Commissions in
making their recommendations. The first Finance Commission laid down certain
principles as follows :
Firstly, the additional transfer of resources from the centre must be such as the centre
should bear without undue strain on its resources taking intoaccount its responsibility
for such vital matters as the defence of the country and the stability of the economy.
Secondly, the principles of distribution of resources between !he states and the
determination of grants-in-aid must be uniformly applied to all.
Thirdly, the scheme of distribution should attempt to lessen the ipequalities between
the states (First Finance Commission Report).
The First Finance Commission further observed: "It is not the purpose of any system
of grants-in-aid to diminish the responsibilities of the State governments to balance
their own budgets. The method of extending financial assistance should be such as t o
avoid any suggestion that the Central Government had taken upon themselves the
responsibility for helping the states to balance their budgets from year to year."
The Eighth Finance Commission gave primacy to national interest as a whole. Their
paramount consideration was reconciling the need to accelerate the development of!
backward states without hindering the further development of the more advanced
ones. The commission, therefore, took steps to reduce the regional imbalances
between the states in addition to covering revenue gaps.
Admidstration :Basics The Ninth Finance Commission (Second Report) also observed :
sod ObJcetlva
"The manner of transfer of resources should be such as to preserve fiscal autonomy
of the states and to promote fiscarresponsibility on t h l part of both the centre.and
the states. Central transfers invariably involve questions of inter-state equity and such
equity can be attained in a system of federal ,transfers only if fiscal prudence, tax
effort and growth impulses are not penalised."
Resource Transfers
Share of Income Tax :Article 270(1) of the Constitution provides for distribution of
taxes on income between the union and the states, in such manner as may be
prescribed by the President after considering the recommendations of the Finance
Commission.
The First Finance Commission fixed the state's share of the divisible pool at 55 per
cent which.karlier was 50 per cent..This was progressively raised to 60 per cent,
66 per cent, 75 per cent by the second, third and fourth Commission respectively.
The sixth and seventh commissions raisedit hrther to 80 per cent and 85 per d n t
respectively. m e eighth and ninth Finance Commissions have retained it at that level.
S b of Excise Duties : This is another tax whose proceeds are shared by the union
with the states. Under Article 272 of the Constitution, union duties on excise other
than that on medicinal and toilet preparations as mentioned in the union list are
levied and collected by the centre, but if Parliament provides by law may be shared
between the centre and the states. The states' share has F e n successively mcreased.
The growth is mainly due to :
a) increase in the number of commodities taxed
b) increase in rates
c) rise in prices; and
d) increase.in the output of taxable commoditiks.
The states' share in divisible pool of excise duties was 40 per cent of only three
commoditiks. The share was raised by the second and third commissions and fourth
commission raised the share to 20 per cent of all commodities. The fifth and sixth
finance commissions maintained the level, seventh commission raised it to 40 per.cent
.
of all commodities, eighth raised it to 45 per cent of all commodities. Ninth
Commission retained it at that level.
Grants-in-aid :Under Article 280 of the Constitution, the Finance Commissions have
been given the right of making recomniendations regarding the payment of
grants-in-aid of the revenues of the states out of the Consolidated Fund of India.
Article 275 provides for the payment of such funds to the states which are actually .
in need of assistance. But the controversies that arise with regard to grants-in-aid is
because the term 'need' has not been clearly defined in the Constitution. The first
Finance Commission listed six principles of grants-in-aid which have been followed
by later Finance Commissions also with varying degrees of emphasis. These are :
1) budgetary needs;
2) tax efforts;
3) economy in expenditure
4) standard of social services.
5) special obligations; and
6) broad purpose of national importance.
The first Finance Commission recommended specific grants for jute producing states,
special grants to eight states for promoting primary education. The second Finance
Commission did not recommend the grants for primary education.
The seventh Finance Co-on twk'the view that grants-in-aid should only be a
residuary means of assistance and should be used not merely to fill in the uncovered
revenue gaps but should be used to narrow down the disparities in the standards of
administrative and social services of the states. The eighth Finance Commission
broadly agreed with the views of the seventh Finance Commission. The successive
Finan& Commissions have, therefore, broadly followed the residuary financial
assistance approach in recommending the grants-in-aid.
The basic objectives underlying the ninth Finance Commission's approach and
methodology were :
a) phasing out the revenue deficit of the Centre and States in such a manner that
the deficit is reduced to zero or a relatively small figure by 31st March, 1995;
b) equity in the distribution of fiscal resources both vertically and horizontally; and
c) promotion of fiscal discipline and efficiency in the utilisation of resources.
The Finance Commissions, have played a very important role in the field of federal
finance, in spite of certain limitations under which,they had to function. Some of
these limitations include :
i) Constitutional limitations =.it has to function under the given framework.
ii) Constraints imposed by the Union on the Finance Commission by prescribing
certain terms of reference.
iii) Non-implementation of important recommendations of the Finance Commission
by the union government.
iv) Problems arising out of the methodologiesfollowed by the Finance Commission.
Some of the states have made suggestions for improving the working of the Finance
Commission. These have been Summarised by the Sarkaria Commission as follows:
a) m e funmons of he-Finance bmmission be enlarged. It should 2;s ~onsider
plan and other transfers andlor undertake comprehensive annuallperiodical
reviews of theefinancial performance of the Union and State Governments.
b) The Finance Commission should be made a permanent or standing body to cope
with enlarged responsibilhies.
c) The coordination between the Finance Commission and the Planning
Commission should be improved so that an integrated view of the flow of Central
assistance to the States becomes possible.
d) It should be provided with a permanent and well-equipped secretariat to carry
out studies and maintain operational continuity for the benefit of the subsequent
Fiance Commissions.
As regards the terms of reference being given by the centre, it has already been
pointed out earlier that differences of opinion betyeen the states themselves do not
allow a consensus to emerge. The union government,.however, initiated steps to
securestherepresentation of states on an official level committee set up to finalise the
terms of reference. This arrangement is considered adequate for the purpose.
On the non-implementation of the recommendations of the Finance Cdmmissioni,
the Sarkaria Commission has listed three such occasions upto Seventh Finance
Commission which the central government could not implement for various reasons.
However, the criticism that the union government did not implement the report of
the eighth Finance Commission in the first year itself, has been found to be valid and
the Sarkaria Commission calls it rather unfortunate. It hopes such occasions will not
arise in future.
There has been a long-standing suggestion that the Finance Commission should
consider plan and other transfers in addition to non-plan revenue transfers. While
conceding that plan transfers could be considered by them, the fourth Finance
b'inancial Administration : Basics Commission observed that "the importance of planned development is so great that
and Objectives there should not be any division of responsibility in regard to any element of plan
expenditure. The Planning Commission has been specially constituted for advising the
Government of India and the State Government in this regard. It would not be
appropriate for the Finance Commission to take upon itself the task of dealing with
the State's new plan expenditure"
The suggestion regarding a permanent Finance Commission did not find favour with
the Sarkaria Commission which felt an active involvement of the Finance Commission
in determination of annual transfers would be at the cost of objectivity.
There is no denying the fact that the Finance Commissions have done an impressive
amount of work in the field of federal finance, which has been better known as the
Indian Finance Commission's approach to federal finance. Inspite of the several
limitations in their approach and methods, they have on the whole succeeded in
maintaining the basic equilibrium in the finances of the state governments.
The finances of the Union Government are in none too happy a position. There is
no balance from current revenues (surplus on revenue account). The Union finances
have.been reeling under massive deficits leading to desperate remedies in the year
1990-91 and 1991-92 (Refer to Unit no. 6). More than 100 public.sector enterprises
are incumng losses every year. Similarly, over the years, most of the states have given
exemptions on Land Revenue, etc., whereas the gross volume and value of
agricultural production have increased manifold during this period. Only a few states
are levying a nominalbAgricultural Income Tax and that too to an insignificant extent.
It
Agricultural Income Tax is not easy to administer. Large commercial losses have also
been incurred by the public sector enterprises year after year.
I
The difference between the states own resources and their revenue expenditures over
a period of years is not an infallible measure of the extent of their dependence on
the resource transfers from the Union. The main snag is that the quantum of revenue
expenditure of a state carries a substantial component relatable to revenue received
by transfer from the union. This component is a variable factor which has an
incremental effect on the level of the'state's revenue expenditure. The so-called
narrow tax-base of the states, therefore, cannot be related quantitatively to the level
of their revenue expenditure as the latter itself depends upon their total revenue
res,ources including revenue transfers from the Union. A state government has in fact
conceded after a quantitative analysis that the state's indirect taxes (Sales Tax on
Passengers and Goods, Electricity Duty and Stamp Duties and Registration Fees) are
fairly elastic to prices and income, but their direct taxes such as Land R e ~ e n u e ~ a n d
.Profession Tax, are highly inelastic.
If one takes note of the broad trends of revenue centralisation and expenditure
decentralisation in other federations, one can say that generally all over the world,
the federal governments have a large and increasing control over revenues. This is
particularly true of Australia and to a large extent of the United States of America.
A more balanced situation, however, exists in Canada. A comparative study
conducted under the auspices of National Institute of Public Finance and Policy has
observed.
I "We may conclude that there is a slightly higher degree of centralisation of
I revenues in India than is generally found in the economically developed
I
federations. But the expenditure decentralisation in India is greater than in those
federations. As a result, the degree of dependence on the centre, in terms of the
I
share of federal transfers in State's revenue is higher. However, in so far as the
transfers take place in the form of Constitutionally assigned taxes the high share
i of federal transfers cannot be said to be an indication of dependence"
Financial Administration : Basics Indebtedness of States : One of the major problem areas in Centre-State financial
and Objectives
relations pertains to the mounting central loans. As per the Ninth Finance
commission Report (second Report), total debt of states is estimated to be Rs. 899461
crore, as on 31.3.89 of which liabilities to the central government form about 63 per
cent. Provident funds, reserve funds and deposits are the next largest source of debt
financing, amounting to 23 per cent of the state's total debt. Market loans constitute
almost 12 per cent of the debt and the residual is negotiated loans from public
financial institutions and others. About 11 per cent of the debt is short-term.
The major cause for the rapid rise in state's indebtedness'is due to investment under
the plans, but more recently to the states resort to cover part of revenue expenditure.
As far as market borrowings are concerned,-under each five year plan, each state is
allocated a share on a net basis, i.e. of repayments due in the year. The states find
that their repayment obligations to the centre are absorbing a large and
ever-increasing proportion of fresh loans. These cut into plan resources to a
substantial extent.
The states' representation to the Ninth Finance Commission, among others, was in
regard to.reduction of repayment burden, write-off loans used- for social
infrastructure, the pattern of central plan assistance to be changed to have a higher
proportion of grants, e.g. 50:70 proportion of grants to loans, etc.
In channeling market loans, allocation of capital funds by the centre favour the
weaker states. Had the moneys been borrowed by all the states directly from the
market, the richer states would have gained in competition. The Ninth Finance
Commission points out that if the centre is asked to bear the cost of borrowing funds,
the amounts available for direct transfers to the states would be reduced. The
"Central Government is not acting merely as a financial agent on behalf of the States
in order to reap economies of scale in obtainiog funds from me market, but also aims
to fulfil certain national purposes such as promoting development and helping weaker
States". It felt that the solution to the government debt problem lay in using
borrowed funds efficiently and productively for capital expenditure instead of
revenue expenditure. It held that, in future, scheduling of loans should be avoided
and that the terms on which the funds were lent by the centre to the states must be
reasonable and equitable. It recommended certain debt relief measures for the states.
According to Sarkaria Commission :
"The present division of fields of taxation between the Union and the States is
based on economic ;nd administrative rationale. Levying of taxes with inter-state
base and where uniformity in rates is desirable, are with the Union Government.
Taxes that are location-specific are with the States. Consensus of efficiency and
equity in administration of taxes and the imperative need for the Union to have
adequate resources, inter alia, to help the States with lower level of
socio-economic development and tax-potential leave hardly any scope for
shifting any major sources of revenue of the States from the present allocation
of areas of taxation to the Union". We may note here the views of the
Administrative Reforms Commission Study Team that "if at all, a review of
taxation power is carried out, economic considerations would most probably
compel a shift in favour of the Union and not the other way"
4) Point out the areas of conflict in federal finance between the centre and states.
.........................................................................................................
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.........................................................................................................
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.........................................................................................................
i Council is the apex body of the nation for the approval of the various plans and
policies. The Planning Commission recommends transfer of resources by way of
t assistance for the execution of the State Plans including Centrally Sponsored
Schemes. In spite of the criticism that the Planning Commission's recommendations
j are dependence-generating for the states, by and large it is' felt that these transfers
are fairly objective and flexible.
' A s we have discussed in the unit, a critical a p p r a h l of Centre-State financial
relations indicates inadequate devolution of resources to the states, heavy
dependence of states on Centre for finances, increasing indebtedness of states etc.,
which need careful examination.
Financial Administration : Basics
and Objectives 5.7 'KEY WORDS
Capital Expenditure : It is the expenditure incurred for creating concrete assets of a
material character in the economy like land, building, machinery etc.
Centrally Sponsored Schemes: Plan schemes sponsored by Central Ministries on
subjects falling in the State list, to be implemented by the state governments, financed
largely by the central government.
Concurrent List: Functions of an inter-state nature such as commercial and industrial
monopolies, labour disputes, social legislation etc. have been placed under the
concurrent legislative powers of the central and state governments. In the event of a
clash between the laws of the Central and State Governments over the concurrent
area the former prevails.
Gadgil Formula: Gadgil formula or Income Adjusted Total Population (IATP) was
evolved in 1969-70 to allocate plan assistance among the States. Under this formula,
30% of the assistance is made in the form of grants and 70% in the form of loans.
The total resources allocated to the states on the basis of this formula are determined
in terms of 60% on the basis of population, 10% on the basis of per capita tax efforts,
10% on the basis of continuing major and medium irrigation, power projects, 10%
on the basis of special problems (floods, drought, tribal areas) of individual states,
and 10% was to accrue to the poorer States on the basis of economic backwardness.
Revenue Expenditure: It is the expenditure incurred towards normal running of
government departments.
Sarkaria commission: The Commission on centre-state Relations was formally
constituted by the Government of India, Ministry of Home Affairs on June 9,1983
under the Chairmanship of R.S. Sarkaria (a retired judge of Supreme Court). The
objective of the Commission was to eramine the working of existing arrangement
between the centre and the states and recommend such changes in the said .
arrangement as may be appropriate within the present constitutional framework.
State L i t : It lists functions and powers with respect to which a state legislature has
exclusive powers to make laws (List I1 of Seventh Schedule of the Constitution). It
includes subjects like agriculture, law and order, public health etc.
Terminal Tax: It is imposed on goods arriving in a city or town by rail. It is realised
by the railways on behalf of the municipality on commission basis. '
Union List: It contains the distribution of functions assigned to the Union and in
respect of which the Parliament has the exclusive power to.make laws. It includes
subjects like defence, external affairs, railways etc. (List I in the Seventh Schedule
of the Constitution).
5.8 REFERENCES
Bhargava, P.K. 1982. Centre-State Resource Transfers in India, Academic Press:
Gurgaon.
Dewan Paras, 1981. Union States Fiscal Relations, Light and Life Publishers: New
Delhi.
Government of India, 1988. Report of the Commission on Centre-State Relations,
General Manager: Nasik.
Government of India, 1989. Report of the Ninth Finance Commission (Second
Report), Manager of Publications, New Delhi*
Sinha R.K., 1987. Fiscal Federalism in India, Sterling: New Delhi.
Thimmaiah, G & H. Rao, 1986. Finance Commission and Centre-State Financial
Relations, Ashish; New Delhi.
Thavaraj, M.J.K. 1978. Financial Administration of India, Sultan Chand & Sons:
New Delhi.
Centre-State Financial Relations-11
5.9 ANSWERS TO CHECK YOUR PROGRESS
EXERCISES
Check Your Progress 1
1) Your answer should include the following points:
Taxes which are to be levied and collected by the Union and the entire
proceeds therefrom are to be retained by it. These include Corporation tax &
Customs Duties.
Taxes which are levied and collected by the Union but proceeds are shared
with the states. These are income tax and excise duties.
Taxes which are levied and collected by the union but retained by the states.
These are estate duties and terminal taxes on goods and services.
These are taxes which are. levied by the union but collected and retained by
the states. These are.excise duties on medicinal and toilet preparations
(containing alcohol and opium).
6.0 OBJECTIVES
After going through this unit, you should be able to :
explain the meaning and scope of fiscal policy
indicate the important objectives of fiscal policy
highlight the contribution of fiscal policy in defusing the recent crisis in the
balance of payments faced by the country; and
discuss fiscal policy instruments and their; utility in bringing about a significant
measure of equity and social justice in the society. '
6.1 INTRODUCTION
The term "fiscal" has been derived from the Greek word 'fisc' for basket which
symbolised the treasury or the public purse. It simply means the exchequer or the
government treasury. Fiscal policy is that part of economic policy which is mainly
concerned with the revenues and expenditures of the government. It often includes
public debt. Resources are raised through taxes, non-tax sources and borrowings
within the country and from abroad. The policies that the government pursues in
respect of raising revenues, levying taxes on income, commodities, services, exports,
imports and those relating to public expenditure have a tremendous impact on the
economy.
In this unit we will discuss the meaning, scope and objectives of fiscal policy. We will
also highlight the significance of various instruments of fiscal policy in bringing
about equity and social justice in the society.
The third source for borrowings is the Reserve Bank of India. This is directly
connected to the expansion of money supply and consequently to inflation. The
monetised deficit (that is, the part of the fiscal deficit that leads to an increase in
money supply) has been rising. The monetised deficit of the central government
shows a fair degree of correspondence with the rate of inflation. Apart from the
immediate net increase in expenditure, monetisation of the deficit builds up a level of
liquidity which leads to a general increase in demand, and hence inflation, in the
succeeding years. Thus the government needs to reduce its reliance on all the three
present sources of funds : compulsory borrowings through the banking system, the
monetised deficit and foreign borrowings.
In order to reduce the fiscal deficit, the government has had to permit an increase in
the administered prices of some basic goods and services. It incidentally increased
input costs in the rest of the economy, thereby bringing about cost-push inflation
also. Devaluation of the rupee in July, 1991 led to an increase in import costs.
In order to combat inflation, the Government launched a massive effort to correct
the fiscal imbalance by reducing the fiscal deficit from 8.4 per cent of Gross
Domestic Product (GDP) in 1990-9 1 to 6.5 per cent in 1991-92 and further to about
5 per cent in 1992-93. Other measures in this direction include
containing the growth of aggregate demand;
tightening of selective credit controls; and
revamping and extending the public distribution system.
Results will take some time to show up.
Balance of Payments
The domestic and external sectors of an economy are interrelated. When domestic
income is equal to domestic expenditure, the external accounts are in balance. Excess
domestic demand caused by an excess of investment over saving leads to domestic
inflation. It can also result in a deficit in the balance of payments.
India entered the decade of nineties with large internal and external financial
imbalances which made the economy highly vulnerable to external shocks. The Gulf
crisis resulted in a higher import bill and a further loss of export markets and
remittances. External commercial borrowings declined sharply. The drying up of
commercial loans was accompanied by a substantial net outflow of deposits by Non-
Resident Indians. The rapid loss of reserves prompted the government to take,a
number of counter measures leading to a reduction in imports. Import reduction
beyond a point would affect the entry of the essential inputs into industry and
transport, petroleum products and fertilisers. This led to a decline in industrial
production and a fall in exports as import compression had reached a stage when it
threatened widespread loss of production and employment and verged on economic
chaos. The government, therefore, moved to implement a programme of macro-
economic stabilisation through fiscal correction.
A key element in the stabilisation effort was the attempt to restore fiscal discipline.
Both the balance of payments problems which were building up over the past few
years and the persistent inflationary pressure were the result, of large budgetary fiscal
deficits which characterised the economy year after year. The budget deficit was
about Rs. 11,000 crore in 1990-91. A reversal of the trend of fiscal 'expansionism was
essential to restore macro-economic balance in the economy. The budget for 1991-92
brought down the deficit to about Rs. 7,000 crore. Similarly, reduction in the fiscal
deficit (the overall resource gap of the Government) was envisaged by about two
percentage points from around 8.4 per cent of GDP to 6.5 per cent of GDP. This
was to be followed by a further reduction in 1992-93 to 5 per cent of the GDP.
These improvements in fiscal performance were made possible by the decision to
abolish export subsidies, increase fertiliser prices, as well as the steps taken to keep
non-plan expenditure (including defence expenditure) in check. These measures have
reduced total expenditure, thereby reducing the current account deficit.
These fiscal policy measuns have been complemented by (i) exchange rate
adjustment (devaluation of the rupee), (ii) a programme of structural reforms of
trade, and (iii) industrial and public sector policies. The objective is to evolve an
industrial and trade policy framework which would promote efficiency, make the
, economy internationally competitive, promote exports and generally integrate the
Indian economy with the global economy. While the crisis has blown over, the policy
reforms introduced by the government are necessary from the long term point of
view.
Cut in Expenditure
Ever since the beginning of the planning era in India, the central government
expenditure has increased enormously. The total expenditure which was Rs. 529
crore in 1950-51 has gone up to Rs. 1.19.087 crore in 1992-93 (budget estimates), an
increase of 225 times. Revenue expenditure has grown at a faster rate. It went up
from Rs. 347 crore in 1950-51 t o 89,570 crore in 1992-93. Capital expenditure,
however, grew at a slower pace. It increased from Rs. 183 crore in 1950-51 to
Rs. 29,5 17 crore in 1992-93, an increase of 161 times. All this when the national
income during the same period went up from Rs. 8,938 crore to Rs. 4,25,672 crore
(estimated), which is about 48 times. (For further details, see Unit 10 of Block 3.)
Another disturbing feature of the Union Budgets is the mismatch between revenues
and expenditure of the wrong kind. Beginning with second plan right up to fifth
plan, the revenue account of the budget always had a surplus and this partly offset
the deficit in the capital account. But during the sixth plan the revenue account no
longer assumed the "compensatory role". Beginning 1988-89, the capital account has
been showing a surplus and thus playing the reverse role of moderating the revenue
account deficit. Thus the plain meaning of this situation is that the government
cannot raise enough revenues to sustain the ordinary business of governing the
country. It has to borrow from the capital market to pay for its day to day expenses.
I
What an underdeveloped country should aim at is to have a surplus in its revenue
account by raising maximum resources, through taxation, and by keeping the
consumption expenditure as low as possible. This surplus should be used to finance
the capital budget. The deficit on the revenue account is either an index of an
inadequate tax policy or possible extravagance in public expenditure on consumption
or both. Such deficits would mean negative savings and consumption of capital.
The effect of deficit financing is to cause a rise in the domestic price level and to
generate demands for wages. This leads to an increase in prices of input costs
making the economy noncompetitive. Substitution of foreign goods for domestic
goods may lead to balance of payments problems and depreciation of the exchange
value of the rupee. A reduction in government expenditure, by reducing excess
demand, will soften inflationary pressure.
I
Can government expenditure be reduced? "The newly evolving analysis of
bureaucracy by economists provides more rigorous underpinning for an old
I
conclusion popularly known as 'Parkinsons Law' (Refer to Section 6.7 for
j
explanation). Bureaucrats maximise their own utility and the principal variable in
I their "utility function" is power. Power can be roughly measured by a proxy such as
I the size of the bureaucrat's budget, or the size of the department by the number of
'
I employees. Bureaucrats identify themselves with the stated goals of their department
and achieve their satisfaction in life in large part by expanding their activity. They
I
will strongly resist any attempt to dismantle a government organisation. The
governments, even when they make genuine efforts to reduce expenditure, usually d o
iI
so by slowing down the rate of expenditure growth. Reduction in the absolute level
of expenditure is rarely possible. Dahl and Lindblom pointed out in 'Income
Stabilization in a Developing Democracy' (Max Milliken, ed. Yale University Press.
New Haven 1956), government expenditures generally mean that "services are
performed, values are realised, administrative organisations developed, expectations
expanded, clienteles formed, interest groups created, pressures mobilised, and once
these are set in motion, they cannot easily be contracted".
The balance of payments crisis that overtook the government left it with no option
but to take corrective fiscal action immediately. Containing and reducing non plan
expenditure has been the avowed policy of the government for some years now. It is
only with the budget for 1991-92 and 1992-93, that a serious effort has been made in
this direction. The important policy initiatives introduced in the 1991-92 budget
included (i) reduction in the fertiliser subsidy; (ii) abolition of cash compensatory
scheme; and (iii) disinvestment in some selected public sector enterprises. As a result
of these adjustments, the provision for nonplan expenditure, excluding interest
payments, in 1991-92, represented a reduction of about 5 per cent compared with the
provision in the revised estimates for 1990-91, and a reduction of almost 15 per cent
in relation to what would have had to be provided, but for the fscal correction.
Interest charges are the largest single item of nonplan expenditure and account for
Rs. 32,000 crore in the budget estimates for 1992-93 and account for about 27 per cent
of the total expenditure and about 38 per cent of the nonplan expenditure. The
provision for 1992-93 represented an increase of Rs. 4,750 crore over the revised
estimates for 1991-92. lnterest charges are a committed expenditure reflecting the
cumulative effect of past deficits. These charges can be controlled by reducing the
reliance on borrowed funds, and making the debts productive and self-liquidating. In
the ultimate analysis, a reduction in revenue expenditure and hence revenue deficit
can alone provide a solution of lasting nature. This indeed is a daunting task.
Expenditure on defence and subsidies are the other major components of nonplan
expenditure. In real terms, the defence expenditure has already been contained, if not
marginally reduced. The question of subsidies is being investigated by a
Parliamentary Committee.
In any effort at reducing expenditure and hence deficits, the first casualty usually is plan
expenditure. Even though in nominal terms, plan expenditure is marginally Higher, in real
terms it represents a significant reduction. This is in tune with the new economic
philosophy of the government which accords larger economic space to the private sector.
With this multipronged strategy, the government has been able to bring down the fiscal
deficit from 8.4 per cent of the GDP (1990-9 1) to 6.2 per cent in 1991-92and hopes further
to reduce it to almost 5 per cent in 1992-93. This shows a welcome recognition of the
paramount need to restore macroeconomic balance and manage the balance of
payments.
The reduction in the incidence of poverty is being brought about both by (I) the
growth of the economy, particularly in agriculture, and (2) by the implementation of
development programmes especially designed to improve the incomeearning
L opportunities of the poor. In the coming years, the Centre's expenditure policies will
accord an even higher priority to programmes benefiting the poor, such as the
Integrated Rural Development Programme, the National Rural Employment
li Programme and the Rural Landless Employment Gaurantee Programme. In addition
to the budgetary allocation for Rural Development programmes, an additional
allocation (1992-93) is to be made available from the corpus of the National Renewal
Fund for employment generation schemes to supplement the normal employment
generation through the Jawahar Rozgar Yojana. An additional allocation of
foodgrains, through the Public Distribution System, in the 1700 most backward
blocks at a subsidised rate, is another step for protecting these vulnerable sections of
society from the pressure on prices.
Another important way in which fiscal policy can contribute to the reduction of
poverty is to encourage rapid economic growth and fast expansion of productive
employment opportunities. Taxation has significant effects on savings and investment
in the economy,on the allocation and uses of resources between alternative sectors,
and on the efficiency with which resources are utilised.
A progressive tax structure becomes inevitable if inequalities of income are to be
reduced. Nor~mlprocess of industrial development always benefits the affluent
sections of society. It is from them that resources can be mobilised for financing
poverty alleviation programmes. Such a tax structure would rely heavily on direct
taxes on income and wealth. Our tax structure, unfortunately, relies largely on
indirect taxes. The time is ripe to have a look at the tax system which has evolved
over a long period and has become extremely complex. The taxation system has to
be simplified, made more progressive so that none of our basic objectives of growth
and social justice are compromised.
Food subsidy is a pan of the system of food security for the poorer and weaker
sections of the population and is a basic element in the social policy. This is being
continued. Fertiliser subsidy has become the largest single subsidy in the fiscal
system. There is no doubt that fertiliser is an essential ingredient for agricultural
*
production. Agricultural development is vital not only for economic growth in
general, but also to ensure rising levels of income and employment in rural areas. In
1980-81, fertiliser subsidy was just 12 per cent of the total allocation in the Central
and State Plans taken together, for Agricultural Rural Development Special Area
Programmes and Irrigation and Flood Control. It increased to 33 per cent in 1991-
92. Measures for better targeting and containing it are under investigation. For the
present, this is being continued.
Thus ends of social justice and equity are being served by the fiscal policy. Once the
economy goes through the macro-economic stabilisation and structural reforms come
to fruition, it should be possible to do much more in programmes of poverty
alleviation, employment generation, public distribution systems, etc.
REFERENCES
Government of India, 1985. Long Term Fiscal Policy, New Delhi.
Government of India, 1991. Economic Survey 1991-92, Manager. Government of
India Press, h e w Dclhi.
Government of India, 1992. Annual Budget 1992-93, Manager, Government of India
Press, New Delhi.
Gowda, Venktatagiri K.. 1987. Fiscal Revolution in India, Indus Publishing Company,
New Dewi.
Thavaraj, M J.K., 1978. Financial Administration in India, S u l t a n - C h d & Sons,
N-...naw;
ANSWERS TO CHECK YOUR PROGRESS
EXERCISES
Check Your Progress 1
I) Your answer should include the following points :
Fiscal policy is concerned with (I) raising financial resources and spending them
and (2) public debt operations to influence the economic activities of the
community in desired ways. It is also concerned with the allocation of resouras
between the public and private sectors and their use in accordance with national
objectives and priorities. It aims at using its three major instruments-taxes,
public expenditure and public debt as balancing factors in the development of
the economy.
2) Your answer should include the following points :
The important objectives of fiscal policy include'the following :
To increase the rate of capital formation.
reduction in economic inequalities of income and wealth.
help in achieving balanced growth.
emphasise on the provision of economic and social overheads.
guidance in designing d progressive tax structure.
7.0 OBJECTIVES
After studying this unit. you should be able to :
state the meaning and components of budget
explain the general characteristics of budgeting systems
identify the important functions which budgets usually perform; and
describe the classification system according to which budgeted expenditures are
classified.
7.1 INTRODUCTION
A single item of public expenditure or that of public revenue cannot be judged in
isolation. Whereas public expenditure is designed to promote welfare, the taxes
impose costs on the tax payers. The welfare and costs, utility and disutility of
government financial transactions, need to be balanced. The demands for
expenditure have to be balanced against the available resources. A b-udget is,
therefore, a financial plan for rationing scarce resources amongst various demands
for expenditure. Over the last few decades, however, budgets have become extremely
complex and pervasive. According to Gladstone "they are no longer affairs of
arithmetic but in a thousand ways go to the root of prosperity of individuals, the
relations of classes and strength of kingdomsw.Thus the concerns of budget makers
are not just financial, that is, producing a balance between expenditure and revenues;
rather these are economic, political, social and administrative in nature.
In this unit, we will discuss the meaning, characteristics and functions of budget. The
three-fold classification of budget shall also be examined.
7.2 BUDGET-MEANING
qrbudget is a statement containing a forecast of revenues and expenditures for a
period of time, usually a year. It is a comprehensive plan of action designed to
achieve the policy objectives set by the government for the coming year. A budget is
a plan and a budget document is a reflection of what the government expects to do
in future. While any plan need not be a budget, a budget has to be necessarily a
plan. It shows detailed &location of resources and p r o p o d taxation or other
measures for their realisation. More specifically, a budget contains information
about :
-8 MP-Y i) plans, programmes, pro~ects,schemes and activities-current as well as new
sydwm-I proposals for the coming year;
ii) resource position and income from different sources, including tax and non-tax
revenues;
iii) actual receipts and expenditure for the previous year; and
iv) economic, statistical and accounting data regarding financial and physical
performance of the various agencies and organs of the government.
A budget is, however, not a balance sheet (exhibiting total assets and liabilities) of
the government on a particular date but refers only to information explained above.
It is a financial blueprint for action and is, therefore, of great advantage to
government departments, legislatures and citizens.
Aecount.bility
In the early phase, legislative control and accountability were the primary functions
of the government budget. This arose from the legislature's desire to control (impose,
amend and approve) tax proposals and spending. The executive was accountable to
the legislature for spending-within limits approved by the latter, under several
heads of expenditure, and only for approved purposes. Similar accountability was to
exist within the executive on the part of each subordinate authority to the one
immediately above in the hierarchy of delegation. Accountability continues to be an
important function of the government budget even today owing to its usefulness in
budget execution and plan implementation.
Management
Budgeting is an executive or managerial function. As an effective.tool of
management, budgeting involves planning, coordination, control, evaluation,
reporting and review. Many of the budgetary innovations such as :
functional classification,
performance measurement through norms and standards,
accounting classsification to correspond to functional classification,
costing and performance audit and use of quantitative techniques
have become important aids to management. Various budgetary systems like
performance budgeting and zero base budgeting are specifically management-oriented
systems.
Coatml
Control essentially implies a hierarchy of responsibility, embracing the entire range
of executive agencies, for the money collected and expenditure, within the framework
of overall accountability to the legislature. In a democracy, control assumes new
dimensions and gives rise to exceedingly difficult problems. The basic concern in a
truly representative government is to bring about suitable modifcations in the uesign
and operation of the financial system so as to ensure executive responsibility to the
legislature which is the law-making, revenue determining and fund-granting authority.
Legislative control would mean that the legislature can meaningfully, and not merely
formally, participate in the formulation of broad policies and programmes, their
scrutiny, approval and implementation through the annual budget. It also means that
the legislature can effectively relate performance and achievement of the executive to
the objectives and policies as laid down by it.
Members of the legislature are not always adequately acquainted with the
complexities of financial administration, nor can they always understand the
enormity of the vast scale of operations and therefore the level of funds required.
Various devices are, therefore, used to assist legislatures in exercising their legitimate
powers over the executive. The Congressional committees of the United States and
the Parliamentary Select committees of the United Kingdom and India help the
legislature in exercising their control over the public purse. We shall be discussing in
detail about the role of financial Committees in Unit 19 of Block 6 of this course.
Statutory audit also examines the accounts and other relevant records to ensure that
the moneys granted by the legislature are spent strictly in accordance with law. Also,
audit tries to ensure that the government obtains value for the tax-payers' money
and that the norms of economy, efficiency and effectiveness are observed.
Planning
Budgeting provides a plan of action for the next financial year. Planning, however,
involves the (i) determination of long term and short term objectives,
6udg&al and Budgetary
Sy*1111-l
($determination of quantified targets, and (iii) fixation of priorities. Planning also
spans a whole range of government policies keeping the time factor and inter-
relationships between policies in view. Planning envisages broad policy choices. At
the level of projects and programmes, the choice is between alternative courses of
action so as to optimise the resource utilisation. The goals of public sector, viz.,
(i) optimal allocation of resources, (ii) stabilisation of economic activity. (iii) an
equitable distribution of income, and (iv) the promotion of economic growth are all
pursued in an organisational context. In the short-run, achievement of these goals
has to be co-ordinated by means of administrative and legal instruments among
which budget policy and procedure are the most important. Planning in the budget
process reflects political pressures as well as financial pressures and financial
analysis.
Object-whe CLurllication
Traditional budgeting ensures control of expenditure and the need t o ensure
accountability of the executive to the legislature as well as that of the subordinate
formations of the executive to the higher echelons. The budget is divided into
sections according to organisational units, departments, divisions and expenditure is
detailed by each category such as salary, wages, etc. A typical classification would be
as follows :
I) Salary
2) Wages
3) Travelling allowance
4) Office expenses
5) Machinery and equipment
6) Works
7) Grants-in-aid
8) Other charges
9) Suspense account
Merit8
i) As a l m d y stated, the rationale for this type of classification was the need to
facilitate control and accountability. Inter-agency, inter-organiation and inter-
department comparison of expenditure could easily be made. This information
would also be available on a time-aeries basis, that is, from year to year, so that
the departments conarned could be pulled up if the expenditure trends, as
revealed through this classification, were not satisfactory.
ri) It shows clear allocation of funds. For example, what percentage of the Covannmt Bdgdhg :PrMpla
expenditure is on salaries, travelling allowances, etc. and Functbm
I Deadta
i) The basic philosophy of budgets with this type of classification is that spending
the budgetary allocation is in itself a virtue. Whatever the amount allocated to a
I particular object it has to be spent, without emphasis on the likely outcome of
that expenditure. Since control is not related to performance, it easily
! degenerates into wastefulness and extravagence. Performance thus takes a back
seat.
ii) Emphasis is laid on procedural considerations, legality and regularity of
expenditure and all the complex rules that are framed to satisfy regularity audit.
Evaluation, justification for expenditure and obtaining value for money become
only incidental.
iii) Inadequate information is available about the government's objectives and
programmes. The emphasis on control and accountability exerts an influence on
the criteria which govern budget decisions. Programme control, contribution to
development, programme co-ordination and efficient resource allocation are
neglected.
iv) Any duplication, redundant activities and expenditure are hard to detect and
avoid.
v) It is only the most pressing demands which receive attention of the budget
makers. Policies, programmes and projects which have only long term benefits,
usually get postponed year after year.
Functional Claesificrtion
Performance budgeting is based on a "conviction that the way in which revenue and
expenditure are grouped for decision making is the most important aspect of
budgeting''. A functional classification of the budget is necessary under the system of
performance budgeting. The presentation of budgeted expenditure should, therefore,
be in t e r n of functions, programmes, activities and projects. Such a classification is
an aid to the managerial function of performance measurement relative to the costs
incurred. The output of a prograrnmelactivity in terms of physical targets has to be
related to the inputs required. These are translated into financial terms and shown as
the budget provision asked for the implementation of the programmelactivity. The
scheme of functional classification is outlined below :
FUNCTIONAL CLASSIFICATION
The terms function, programme, activity and project have definite connotations; in
practice, however, these can be quite flexible, the only requirement being that these
terms should be used in a consistent manner over the entire span of a departmental
budget and also as between different departments of the government.
This type of classificat~onprovides information about the nature of sources of the
government and the share of public expenditure directed towards that particular
budgetary control-administrative accountability.
An important point to be noted is that the total budget provision, however classified,
has to be the same; as it is the same budget which is submitted to the legislature for
approval.
Economic Clasification
The budget of the government has an impact on the economy as a whole. Because of
its sheer magnitude, receipts and expenditure of the government and various policies
that are articulated through the budget, are easily the most significant factors that
can and do change the very nature, content and direction of the economy. It is,
therefore, important to group the budgetary provisions in terms of economic
magnitudes, for example, how much is set aside for capital formation, how much is
spent directly by the government and how much is transferred by government to
other sectors of the economy by way of grants, loans, etc. Economic classification
categorises government's total expenditure into meaningful economic heads like
investment, consumption, generation of income, capital formation etc. According to
the Economic and Social Council of the United Nations (Economic classification
provides) "an analysis of the transaction of Government bodies according to
homogenous economlc categories of transactions with the other sectors of the
economy directly affected by them". This analysis is contained in a separate
document called Economic and Functional Classification of the Central Government
Budget, and is brought out by the Ministry of Finance. A broad categorisation is as
follows :
8. Total Receipts
(1 + 4) Y3%9
*
d h ~ W i T * @ ~
w-w l
India's credit to Central Government.
..........................................................................................
.........................................................................................
2) What is object-wise classification of budget? Discuss its demerits.
.........................................................................................
.........................................................................................
.........................................................................................
.........................................................................................
3) Explain economic classification of budget.
.........................................................................................
.........................................................................................
............................................................................................
Information on the working of the budgetary process is obtained from the systems of
classification. Transactions of the government can be classified by objects such as .
salaries, wages etc; by function as defence, agriculture, industry etc., or by their
economic character such as consumption, capital formation etc. These are
respectively known as object-wise classification, functional classification and
economic classification. .
7.8 KEY WORDS
Accrual-baaed Accountin# : An accounting system where a system of charging
income and expenditure to the period in which they are earned or incurred is
followed, rathei than to the period in which they are actually received or paid.
Accountability : Responsibility of the various agencies of the government for the
proper management of funds allocated.
Depreciation AUowmce : Allowance provided for the dimunition or reduction in the
value of an asset due to use and/or lapse of time.
Economic C l d c a t i o n :Grouping the budgetary provisions in terms of economic
magnitudes such as consumption expenditure, transfer payments, capital formation,
etc.
Functional Clursification : Presentation of the budgeted expenditure in terms of
functions, programmes, activities and projects.
InmmenW Budgetin# :A system of budgeting in which the bulk of expenditure on
the on-going activities of the government is left untouched, only marginal
adjustments (incremental) are made in raising and allocating revenues.
Line-item CLesiiication :The system of classifying expenditure by organisations
(Ministries and departments of the government) and objects of expenditure such as
salary, transport, material contingencies etc.
7.9 REFERENCES
Burkhead jesse, 1956. Government Budgeting, John Wiley & Sons: New York
Premchand A, 1983. Ciovernrnerit Budgeting and Expenditure Control: Theory and
Practice, JMF: Washington DC
Thavaraj, M. J. K., 1978. Financial Administration of India, Sultan Chand & Sons :
Delhi
resource position and .income from different sources including tax and non-
tax revenues.
actuil receipts and expenditure for the previous year, and
-economic, siatistical, and accounting data regarding financial and physical
performance of the various agencies and organs of the government.
2) Your answer should include the following points :
Strong emphasis on expenditure control with itemised ceilings and sanctions.
Tendency towards incrementalism.
No attempt to relate inputsto outputs or expenditure to performance
benefits.
Short time-span of one year.
I ~ u d g a h gand Budgauy
SyJ~ras-1
Check Your Progress 2
I ) Your answer should include the following points :
Accountability
Management
Control
Planning
2) Your answer should include the following points :
Object-wise classification of budget is one where the budget is divided into
sections according to organisational units, departments, divisions etc. and
expenditure is indicated by each category like salary, wages, travelling
allowances etc.
Demerits of classification are :
Control is not related to performance.
Procedural considerations, legality and regularity of expenditures, complex
rules are given importance; evaluation and justification for expenditure
become incidental.
Inadequate information is available about objectives and performance of
government.
Duplicate, redundant activities and expenditure are hard to detect and avoid.
3) Your answer should include the following points :
Economic provisions in terms of economic magnitudes should for example,
indicate how much is set aside for capital formation, how much is spent
directly by the government and how much is transferred by government to
other sectors of economy by way of grants, loans dc.
It categorises government expenditure into meaningful economic heads like
investment, consumption, generation of income, capital formation.
UNIT 8 INDIAN BUDGETARY SYSTEM
Structure
8.0 Objectives
8.1 Introduction
8.2 Evolution of Budgeting System in India
8.3 Principles or Budgeting
8.4 Financial Year
8.5 The Budgetary Process
8.6 Budgetary Cycle
8.7 Let Us Sum Up
8.8 Key Words
8.9 References
8.10 Answers to Check Your Progress Exercises
8.0 OBJECTIVES
-- -
INTRODUCTION
Even though budgetingin ancient and medieval lndia was known not only in its
essentials but in fairly great detail, modern budgetary practices started taking shape
with the governance of the country being taken over directly by the British Crown.
Broadly, the evolution of budgeting has passed through three stages. Firstly, the
budgeting system was a sub-system of the British administration. The financial
objectives were subordinate to the limited objectives of the colonial power. Control
of expenditure and accountability were the hallmarks of this period. Secondly, with
the attainment of Independence, the developmental priorities of the nation
superseded the limited objectives of the British Raj. In the third phase, a planning-
orientation has been sought to be imparted to the budgetary exercises. These three
phases correspond to the systems known as incremental budgeting, performance
budgeting and zero base budgeting respectively. The system described in the
following sections is that which is currently practised and is the end result of all the
budgetary innovations introduced with varying degrees of success.
In this unit, we Will discuss the evolution of budgeting system in India, principles of
budgeting and rationale of the financial year. The various steps of budget making
and budgetary cycle shall also be focused in the unit.
The rulers of the Delhi Sultanate and the Mughal empire also continued a financial
system not very different from the Mauryan system.
With the advent of the British rule, the lndian financial administration came
effectively under the control of the East lndia Company. Till 1833, the presidencies
of Bengal, Bombay and Madras were quite independent in finance and there was
hardly any centralised financial system. This position changed with the Charter Act
of 1833 which vested the superintendence, direction and control of all the revenues in
the Governor General of India-in-Council.
The main activity of the East lndia Company being territorial expansion,
expenditure on costly wars mounted. Huge sums were remitted to England on
account of interest payable on lndian debt, interest on investment on Railways, civil
and military charges supposed to have been incurred in England on behalf of India,
including the expenses on the maintenance of the O f f i e of East lndia Company in
India. That the Governors of the three presidencies hardly had any powers can be
seen from the fact that no governor could create a permanent post carrying a
princely salary of more than Rs. ten per month.
Following the first war of Independence, in 1857, there was chaos in financial
administration. With the takeover of the Indian administration by the Crown, the I!.
The budgetary system, more or less, retained these features in spite of the reforms
introduced by Lord Mayo in 1870, Lord Lytton in 1877, Lord Rippon's
Quinquennial Settlements of 1882 and Lord Curzon's Reforms, 1904. The scene,
however, changed significantly following Montague-Chelmsford Reforms of 19 19. Indian Budgetry Syslem
From 1921 onwards, the Central Legislative Assembly, with a non-official majority,
was for the first time given the right to discuss and pass the annual budget of the
Government of lndia in respect of 'non-reserved' subjects, as also to pass the Finance
Bill embodying taxation proposals. The Governor-General was, however, empowered
to "certify" the financial proposals in the event of their rejection by the legislature.
Before these reforms were introduced, the provincial governments had to seek the
approval of the Central Government for every rupee spent. The Montague-
Chelmsford Reforms for the first time introduced realistic provincial autonomy.
Central and provincial heads of revenue were clearly demarcated. Consequently, the
importance of the supervisory role of Finance Member over the provincial finance
departments declined considerably and vanished altogether after 1935. The Secretary
of State, however, did not suffer any diminution in his supreme authority after the
1919 d o r m s . Nothing of significance could happen without his knowledge. But he
intervened only when the imperial interests were in jeopardy.
The Government of India Act, 1935, delivered a body blow to his powers. Except for
the control over the services, the Secretary of State gave up direct exercise of most
of his powers. The Governor General and the Governors exercised special powers
and prerogatives over what were called reserved subjects which together with charged
items were outside the purview of legislative financial control. They could also
restore a demand rejected or reduced by the legislatures. Again, no expenditure
could be incurred even if it was duly authorised by the legislature unless it was
included in a schedule of expenditure authenticated by the Governor-General or the
Governor.
Thus the system of financial control, both at the tlme of budget formulation and
approval for incurring expenditure, turned out to be very rigid, rule-oriented and
complex. This system naturally inhibited and suppressed any popular initiative
towards change and development. Understandably, the control over financial
administration was a necessary adjunct of the fundamental imperial objectives. It was
never meant to facilitating solutions to national problems. It was this system, with all
its distortions and rigidities, which India inherited from the British.
FINANCIAL YEAR
When the first modern budget was presented in 1860, the financial year adopted by
the government was from 1st May to 30th April. Beginning with the year 1866,
however, the financial year was changed to April-March, in conformity with the
practice in England. This practice has been the subject of debate and various
committees and commissions which examined the issue have been critical of it. The
Administrative Reforms Commission in its Report on Finance, Accounts and Audit
observed.
"The financial year starting from the 1st of April is not based on custom and
needs of our nation. Our economy is still predominantly agricultural and is
dependent on the behaviour of the principal monsoon. A realistic financial year
should enable a correct assessment of revenue, should also synchronise with a
maximum continuous spell of working season and facilitate an even spread of
expenditure. For centuries, people in India have become accustomed to
commence their financial year on the Diwali day. This practice has its roots in
their way of life. The business community and other sections of society start
the Diwali day with the feeling that they have finished with the old period of
activity and have embarked upon a new one. It is, therefore, appropriate that
the commencement of the financial year should be related to Diwali and in
order to prescribe it in terms of a date, we have recommended that the 1st
November should be the beginning of financial year."
The commission also thought that a budget year commencing on the 1st November
would be better suited for the transaction of Parliamentary business. It is normally
argued that the effect of south-west monsoon, which is responsible for over 90 per
cent of the total annual rainfall in India, would be known by September, and the
likely agricultural production during the year can be estimated fairly accurately. The
commercial and industrial activities are also largely dependent on the performance in
the agricultural sector. Besides, the monsoon months can be utilised for budget
formulation and the critical fiscal parameters can be decided upon in the light of
anticipated level of economic activity in the ensuing year.
Under the present arrangements, soon after the expenditure sanctions reach the
executing agencies, the onset of monsoon renders it difficult to start construction of
the budgeted works. These works have to wait till the rains are over. The speed of
works is affected because of the intervention of monsoons when barely the
preparatory work of projects has been completed. The delayed execution of works
results in the rush of expenditure towards the end of the year leading to surrender of
funds at the close of the financial year.
Essentially a budget year should help in performing the following functions:
i) making a fairly accurate estimates of revenue;
ii) making a fairly accurate estimates of expenditure;
iii) it should facilitate an efficient execution of projects; and
iv) the budget calendar should be convenient to the legislators and administrators.
Different dates have been suggested by the various experts who have examlned the
question of fina-ncial year. These are 1st July, 1st October, 1st November or 1st
January. While there is a merit in each one of these suggestions, none of these can
reconcile the conflicting criteria proposed. Considering only the criterion of better
predictability of revenues, no single budget year provides enough scope for the
various states to make a realistic assessment for both Kharif and Rabi crops. Rabi
crops are very important for some of the states. The estimation of total agricultural
production would, therefore, remain a guess work.
It has, therefore, been argued that the balance of advantage lies in not disturbing the
.
present fiscal year. The database of the economy relates to the existing financial
year and any dislocation in this year will lead to statistical, accounting and lndim Budgauy system
administrative problems. One has to weigh the advantages of changing over to a
different fiscal year against the disadvantages inherent in such a switchover. And one
has to remember that there is no general agreement on the alternative fiscal year.
The only practical appioach, therefore, is to continue with the present financial year.
Contingency Fund
Occasions may arise when government may have to meet urgent unforeseen
expenditure pending authorisation from the Parliament. The Contingency Fund is an
Imprest placed at the disposal of the President to incur such expenditure.
Parliamentary approval for such expenditure and for withdrawal of an equivalent
amount from the Consolidated Fund is subsequently obtained and the amount spent
from Contingency Fund is recouped to the lund. The corpus of the fund authorised
by the Parliament, at present, is Rs. 50 crore.
Public Account
Besides the normal receipts and expenditure of government which relate to the
Consolidated Fund, certain other transactions enter government accounts, in respect
of which government acts more as a banker; for example, transactions relating to
Provident Funds, small savings collections, other deposits etc. The moneys thus
received are kept in the Public Account and the connected disbursements are also
made therefrom. Generally speaking, Public Account funds d o not belong to
government and have to be paid back some time or the other to the persons and
authorities who deposited them. Parliamentary authorisation for payments from the
Public Account is, therefore, not required.
Charged Expenditure
Under the Constitution, certain items of expenditure like emoluments of the
President, salaries and allowances of the Chairman and the Deputy Chairman of the
Rajya Sabha and the Speaker and Deputy Speaker of the Lok Sabha, salaries,
allowances and pensions of Judges of the Supreme Court and the Comptroller and
Auditor-General of India, interest on and repayment of loans raised by government
and payments made to satisfy decrees of courts etc; are charged on the Consolidated
Fund. These are not subject to the vote of Parliament. The budget shows the
charged expenditure separately in the Consolidated Fund.
Government budget comprises :
i) Revenue budget; and
ii) Capital budget
Revenue Budget
It consists of the revenue receipts of government (tax and non-tax revenues) and the
expenditure met from these revenues. The estimates of revenue receipts shown in the
budget take into account the effect of the taxation proposals made in the Finance
Bill. Other receipts of government mainly consist of interest and dividend on
investments made by government, fees, and other receipts for services rendered by
government.
Capital Budget
It consists of capital receipts and payments. The main items of capital receipts are
loans raised by government from public which are called Market Loans, borrowings
by government from Reserve Bank and other parties through sale of Treasury bills,
loans received from foreign governments and bodies and recoveries of loans granted
by Central Government to State and Union Territory governments and other parties.
Capital payments consist of capital expenditure on acquisition of assets like land,
buildings, machinery, equipment, as also investments in shares etc. and loans and
advances granted by Central government to State and Union Territory governments,
government companies, corporations and other parties. Capital budget also
incorporates transactions in the Public Account.
. - -
Budget Preparation
In India, budget preparation formally begins on the receipt of a circular from the
Ministry of Finance sometime during September/October, that is, about six months
before the budget presentation. The circular prescribes the time-schedule for sending
final estimates separately for plan and non-plan, and the guidelines to be followed in
the examination of budget estimates to be prepared by the department concerned
The general rule is that the person who spends money should also prepare the
budget estimates. Budget proposals normally contain the following information:
i) Accounts classification
ii) Budget estimates of the current year
iii) Revised estimates of the current year
iv) Actuals for the previous year; and
.geting and Budgetary V) Proposed estimates for the next financial year (which is the budget proper).
tern-1
Budget estimates normally involve :
a ) Standing charges or committed expenditure on the existing level of service. Thiis
can easily be provided for in the budget, as it is more or less based on a
projection of the existing trends.
b) New expenditure which may be due to :
i) expansion of programmes involving expenditure in addition to an existing
service or facility; and
i ) new service for which provision has not been previously included in the
grants.
\\,,
~ h i l e \ W (i)
) can be estimated with reference to progress made and the likely
expenditure during the next financial year, budget provision for (b) (i) and (ii) cannot
be made unless the scheme relating to it is finally approved.
The budget estimates prepared by the ministries/depanments according to budget
and accounts classification are scrutinised by the Financial Advisors concerned. The
plan items of the Central Budget are finalised in consultation with the Planning
Commission and are based on the Annual Plan.
Parlinmentary Approval
The estimates of expenditure prepared by ministries/departments are transmitted to
the Ministry of Finance by December where these are scrutinised, modified where
necessary and consolidated. The estimates of revenue are also prepared by the
Finance Ministry and thus the budget is finalised. The budget is presented to the
Parliament generally on the last working day of February. In the first stage, there is
a general discussion on the broad economic and fiscal policies of the government as
reflected in the budget and the Finance Minister's speech. This lasts about 20-25
hours.
In the second stage, there is a detailed discussion on the demands for grants, usually
in respect of specific ministries or departments. Each demand for grant is voted
separately. At this stage members of parliament may move motions of various kinds.
Generally these are policy cuts, economy cuts, and token cuts. The policy cut motion
seeks to reduce the demand to rupee one and is indicative of the disapproval of
general or specific policy underlying the service to which the demand pertains. The
motion for economy cut is to reduce the proposed expenditure by a specified
amount. A token cut in a demand is moved to reduce it by a nominal amount say
Rs. 100 and may be used as an occasion to ventilate a specific grievance. Since it is
never possible to accommodate a detailed discussion on each demand for grant
separately, the demands that cannot be so discussed are clubbed together and put to
the vote of the Parliament at the end of the period allotted for discussion.
Though the budget is presented before both Houses of Parliament, the demands for
grants are submitted only to the lower house. Demands for grants, are the
executive's requisitions for sanction to spend, and only the lower house can have a
say in the matter. While the legislature can object to a demand for grant, reject it or
reduce it, it cannot increase the same. It may also be mentioned here that since no
demand for a grant can be made except on the recommendations of the President or
the Governor (in the case of State), private members cannot propose any fresh items
of expenditure. If this were allowed it would necessitate revision of receipts and
consequently the budget and sometimes may lead to improper appropriation of
public funds.
Even after the demands for grants have been voted by the Parliament, the executive
cannot draw the money and spend it. According to the Constitutional provisions,
after the demands for grants are voted by the Lok Sabha, Parliament's approval to
the withdrgwal from the Consolidated Fund of the amount so voted and of the
amount required to meet the expenditure charged on the Consolidated Fund is
sought through the Appropriation Bill. The Appropriation Bill after it receives the
assent of the President becomes the Appropriation Act. Thus, without the enactment
of an Appropriation Act, no amount can be withdrawn from the Consolidated Fund.
Since the financial year of the government is from 1st April to 31st March, it follows
that no expenditure can be incurred by the government after 31st March unless the
--
Appropriation Act has heen passed by the close of the financial year. This is Indian Budgduy System
generally not possible as the process of discussion of the budget usually goes on up to
the end of April or the first week of May. Thus, in order to enable the government
to carry on its normal activities from 1st April till such time as the Appropriation
Bill is enacted, a Vote on Account is obtained from Parliament through an
Appropriation (Vote on Account) Bill.
The proposals of government for levy of new taxes, modification of the existing tax
structure or continuance of the existing tax structure beyond the period approved by
Parliament are submitted to Parliament through the Finance Bill. The members can
utilise the occasion of discussion on the Finance Bill to criticise government policies,
more specifically the proposals regarding the taxation and tax laws. In certain cases,
taxation proposals take effect immediately. Since, however, passing of the Finance
Bill may entail a time lag, a mechanism under which the taxation proposals take
effect immediately pending the prissing of the Finance Bill exists in the form of
Provisional Collection of Tax Act, 1931, which empowers the government to collect
taxes for a period of 75 days till the Finance Bill is passed and comes into effect.
The budget of the Central Government is not merely a statement of receipts and
expenditure. Since Independence, with the launching of five year plans, it has also
become a significant statement of government policy. The budget reflects and shapes,
and is in turn shaped by, the country's economic life. A background of the economic
trends in the country during the current year enables a better appreciation of the
mobilkation of resources and their allocation as reflected in the budget. A document,
Economic Survey, is prepared by the government and circulated to the members of
Parliament a couple of days before the budget is presented. The Survey analyses the
trends in agricultural and industrial production, money supply, prices, imports and
exports and other relevant economic factors having a bearing on the budget.
Audit
The executive spends public funds as authorised by the legislature. In order to ensure
accountability of the executive to the legislature, public expenditure has to be
audited by an independent agency. The Constitution provides for the position of the
Comptroller and Auditor General of India to perform this function. It is his/ her
duty to ensure that the funds allocated to various agencies of the government have
been made available in accordance with law; that the expenditure incurred has the
sanction of the competent authority; that rules, orders & procedures governing such
expenditure have been duly observed; that value for money spent has been obtained
and that records of all such transactions are maintained, compiled and submitted to
the competent authority. This is the last stage in completing the budgetary cycle (for
details see units no. 22 and 23).
3) What are the main functions involved in the execution of the budget?
These are the four stages in the budgetary cycle. viz; preparation, approval, Indian Budgetary System
execution of the budget and audit. Preparation of ihe budget usually begins on the
receipt of a circular from the Ministry of Finance during Se?tember/October. It
contains iriformation relating to the budget estimates of the current year, revised
estimates, actuals for the previous year and the proposed budget estimates for the
next financial year.
The budget is presented to the Parliament on the last working day of February. A
general discussion is followed by a detailed discussion on each demand for grant.
The Parliament may reduce or reject but may not increase any budgetary provision
which is subject to its vote. After the Parliament has voted the demand for grants,
an Appropriation Act has to be passed by it to enable the government to withdraw
money from the Consolidated Fund of India. The executive spends the money in
accordance with the powers delegated to the operational levels. Finally, the
expenditure is audited by the Statutory Audit to ensure that the public funds have
been used as authorised and that rules and regulations have been observed.
KEY WORDS
Resaved Subjects : The Montague-Chelmsford Reforms introduced the division of
subjects at the provincial level into reserved and transferred subjects. The resewed
subjects included important departments which were in charge of councillors who
along with the Governor were responsible to the Secretary of State and British
Parliament. The transferred subjects were in charge of ministers who were
responsible to the provincial legislature.
Rule of h p a e : This is a budgetary principle which implies that no part of the grant
which is unspent by any departmentlministry in any year can be carried forward to
the next year.
Secretary of State :The Act of 1858 ended the rule of East India Company and
Indian administration was brought directly under the British Crown. This Act
created the Office of the Secretary of State who was a Cabinet minister in the British
Cabinet entrusted with the responsibility of managing affairs in India on behalf of
the Crown.
Supplementary Crrrntr : If original estimates in budget are insufficient to carry on
any activity, additional funds are sought by the government from the Parliament in
the course of the financial year through supplementary grants.
Vote-on-Account : Even though the financial year starts on 1st April, the budget
takes some time to be passed. So, to meet the expenditure that will be incurred in
the first few months of financial year till the budget is passed, the
Parliament/legislature is required to pass vote on account which is an advance grant.
8.9 REFERENCES
Burkhead, Jesse, 1956. Government Budgeting, John Wiley & Sons : New York.
Premchand A, 1983. Government Budgeting and Expenditure Control: 7'heory and
Practice, IMF : Washington DC.
Thavaraj, M.J.K., 1978. Financial Administration of India, Sultan Chand and Sons :
Delhi.
9.0 OBJECTIVES
After reading this unit, you should be able to:
explain the various classifications of government expenditure
differentiate between revenue and capital expenditure
distinguish between developmental and non-developmental expenditure
differentiate between plan and non-plan expenditure; and
evaluate the present system of classification of government expenditure.
9.1 INTRODUCTION
This unit deals with one of the important issues in Financial Administration i.e. the
classification of government expenditure. The economy of a country is greatly
influenced by the level of government o r public expenditure. It is one of the major
processes by which the welfare of the people is ensured and it is a vital aspect of a
government's budget. It is an important instrument in the hands of government that can
be utiIised for the maximisation of public satisfaction. Again, it helps in overcoming the
inefficiencies of the market system in the allocation of economic resources. It also helps
in smoothing out cyclical fluctuations in the economy and ensures a high level of
employment and price stability. Thus, government expenditure plays a crucial role in
the economic growth of a country. Government expenditure covers all the expenditure
incurred by government under the account heads of "Revenue", "Capital" and
"loans". Revenue expenditure can be classified into two categories : Non-
developmental expenditure and Developmental expenditure.
Classification of government expenditure is closely related to the objectives of the
government i.e. economic growth, financial control, price stability etc. For instance,
the accounting classification of expenditure into 'Plan' and 'Non-plan', 'Capital' and
'Revenue' enables the Parliament to exercise financial control over expenditure and
. within the government, to exercise financial control over the spending departments.
Similarly, the economic classification of government expenditure helps the government
in determining how much of the economic resources are allocated by government to
various economic activities and their contribution to the economic growth of the nation.
Again, the cross classification of expenditure (i.e. Functional-cum-Economic
classification) serves the social objectives of the government by determining the
expenditure incurred on consumption and non-consumption.
Thus, each classification of government expenditure serves one or other objectives of
the government viz., financial control, economic growth, price stability etc.
Financial Administration In this unit, we shall deal with the various classifications of government expenditure,
points of distinction between capital and revenue, developmental and non-
developmental, plan and non-plan expenditure. .
9.9. REFERENCES
Chelliah R.J. 1969. Fiscal Policy in Underdeveloped Countries with Special Reference to
India, 2nd Edn, George Allen & Unwin: London.
Peacock A.T. and J. Wiseman, 1967. The Growth of Public Expenditure in the United
Kingdom, George Allen and Unwin Ltd. : London.
Reddy K.N., J.V.H. Sarma, and N. Sinha, 1984. Central Government Expenditure,
Growth, Structureand Impact, 1950-51to 1977-78, National Institute of PublicFinance
and Policy: New Delhi.
Singh M.P., 1988. Economics of Government Expenditure and Growth, Reliance
Publishing House: New Delhi.
Sury M.M., 1990. Government Budgeting in India, Commonwealth Publishers: New
Delhi.
EXERCISES
Check Your Progress 1
1) Your answer should include the following points:
Government expenditure covers all the expenditure incurred by government
under the accounting heads of "Revenue", "Capital" and "Loans".
Revenue expenditure is the expenditure incurred for running the government
departments, payment to various services and interest charges etc. Revenue
expenditure does not result in creation of any assets.
~ e v e n u ereceipts comprise taxes and other duties levied by the Union.
Capital Receipts are loans raised by government from public, which are called
market loans, borrowings from R.B.I. etc.
Capital expenditure is the expenditure intended for creating concrete assets of a
material character in the economy.
2) Your answer should include the following points:
Economic classification refers to the resources allotted by government to various
economic activities. It divides government expenditure into meaningful economic
aggregates like public consumption, investment, generation of income, etc. It
enables policy makers to step up expenditures in those sectors, which contribute to
the economic development of the country.
Cross classification or Economic-cum-Functional classification helps in analysing
expenditure, according to its economic character as well as functions. It is found
useful in drawing up a programme of projected expenditure covering a period of
years and in evaluating the progress of actual expenditure against budget
provisions.
10.0 OBJECTIVES
After studying this unit you should be able to:
evaluate the various theories and approaches by different schools of thought
regarding the determination of public expenditure;
explain how public expenditure policies and measures affect different aspects of the
economy;
trace the growth of public expenditure in India and analyse it with the help of theories
discussed; and
highlight the recent trends in public expenditure policies in India.
1 0 1 INTRODUCTION
Consistent with the earlier concept of state as a police state, minimum expenditure by
it was considered to be the best level of expenditure. The analysis of public expenditure
was not, therefore, recognised as a worthwhile field of economic research. Public
finance concentrated on the study of public revenue and issues relating to taxation
rather than the expenditure therefrom. In the post Second World War period, there has
been a phenomenal increase in the level of government or public expenditure both in
absolute terms and also in relation to the national income. There has, therefore, been
a great amount of scholarly interest in understanding the causes of public expenditure,
and its incidence, that is, who benefits from the various components of public
expenditure. The major area of concern has been to channelise public expenditure into
those areas of the economy where its effects will be optional in terms of growth,
consumption and distribution. More recently, however, serious concern has been
voiced regarding the effective utilisation of government funds and the paramount need.
to avoid wasteful expenditure. A correct perspective on Central Government
expenditure, reasons for its massive growth, pattern and direction of its increase,
effects on the economy, recent trends and the need to control it, are issues which are
central to the understanding of financial administration. These are precisely the issues
which will be examined in this unit.
Public Choice
The recognition of the importance of the political processes in revealing public
preferences has, in due course, contributed to the growth of "public choice" theories.
Anthony Downs offered useful analysis of these political processes. Downs' theory,
which was based primarily on the US systems, provided a general framework for
explanation of public expenditure. In democratic societies, it is held, governments
determine revenues and expenditure to maximise their chances for winning the
election. The budgeted expenditure is determined not with reference to overall
spending and taxation but through a series of separate policy decisions based on
estimates of gains and losses of votes. According to Downs, government will provide
what voters want and not necessarily what is beneficial. Thus the central reality for
governments is the citizen's vote and not his welfare. In order to fulfil voters' demands,
promises made at election time, their aspirations for projects or services, the
expenditure has to expand making for larger government, larger bureaucracies, bigger
budgets and more problems in trying to find resources for financing the budgeted
expenditure.
Positive Approaches -Ic
The positive approaches are concerned with the actual growth of public expf
over a period of time and deal with the formulation and verification @F'~~*
hypothesis. These include: -49 .noQ
,
Financial Administration Wagner's Law
The earliest theory advanced is that of Adolph Wagner in 1876 which came to be known
as "Wagner's law". He propounded the "Law of increasing expansion of public and
particularly state activities" which is referred to as the "law of increasing expansion of
fiscal requirements". The law suggests that the share of the publicsector in the economy
will rise as economic growth proceeds, owing to the intensification of existing activities
and extension of new activities. According t o Wagner, social progress has led to
increasing state activity with resultant increase in public expenditure. He predicted an
increase in the ratio of government expenditure to national income as per capita income
rises. It is the result of growing administrative and protective actionsof government in
response to more complex legal and economic relations, increased urbanisation, and
rising cultural and welfare expenditures. Another reason is the decentralisation of
administration and the increase in the expenditure of local bodies.
According to Musgrave, however, it is not fruitful to seek an explanation for the total
expenditure. Tests carried out by various researchers have shown that the increase in
expenditures is far more complex than is evident from the tests carried out on empirical
data. Therefore, according to Musgrave, it may be far more rewarding to adopt a
desegregated approach (an approach which divides the study of expenditures of
government) through a study of expenditures of government on capital formation,
consumption and transfer payments.
..........................................................................................................
2) Explain public choice theory as a determinant of public expenditure.
..........................................................................................................
3) Discuss Peacock-Wiseman hypothesis on public expenditure.
Consumption
Public expenditure enhances the quality of life of people by providing recreational,
cultural, educational and public health facilities, such as public parks, playgrounds,
libraries, educational institutions, hospitals and dispensaries and scientific, cultural and
commercial exhibitions. Consumption, after all, is the end objective of economic
activity of individuals. By promoting the level of economic activity and a more equitable
distribution of income, the state can bring about a greater sense of social and economic
security in the lives of individuals. The government enables them to live a fuller and
richer life.
Allocation of Resources
Public expenditure allocates resources in accordance with national priorities. The
priorities may be defence, agricultural production and self-sufficiency in food, industrial
development, generation of employment opportunities, an equitable distribution of
income, balanced regional development, population control, a better ecological
Financial Administration balance etc. Public expenditure in these areas is bound to raise the community's
productive power. According to Dalton "increased public expenditure in many of these
directions is desirable in order to bring about that distribution of the community's
resources between different uses, which will give the best results, balancing without
bias the present and future".
Changes in national priorities, from time to time, will be reflected in the pattern of
public expenditure. Again, resource allocation has to take into account the balance
between present needs and future requirements. Apart from imparting a sense of
fairness as between generations, projects with long gestation periods can be undertaken
only by the state. Hence allocation has to keep in view the fact that market economy
cannot always take care of social needs. These can be taken care of only by the state.
Production
The roles of private and the public sectors are complementary. The public sector
provides the infrastructure, transport and communications, power, education and
public health programmes. In the absence of goods and services provided by the
government sector, private sector can hardly make any meaningful contribution
towards production and development: According to Dalton, other things being equal,
taxation should not adversely affect production and public expenditure should increase
it as much as possible. Public expenditure can affect (i) the ability to work, save and
invest, (ii) the desire to work, save and invest, and (iii) allocation of resources as
between different uses. Public expenditure can influence these factors either favourably
o r unfavourably.
The economies of ,developing countries cannot make significant progress unless they
concentrate on development of investment goods sector. This may not result in
production in the immediate future, as in education and health programmes,
infrastructural projects and projects with long gestation periods. This would, however,
certainly build up growth potential in the economy, and help take the economy to a
self-generating level.
Distribution
In Dalton's words, "other things being equal, that system of public expenditure is best,
which has the strongest tendency to reduce the inequality of incomes." A system of
grants and subsidies is equitable in the measure in which it is progressive. This leads to
maximum social benefit. An approximation to this principle would be provided by a
system of grants which would bring all incomes below a certain level to that level (say,
above the poverty line), without adding anything to incomes above that level. A public
distribution system which makes available essential commodities at subsidised prices to
the poor, will also achieve the same result. Free provision of services to all members of
the society e.g., free health service o r free education, "narrows the area of inequality".
Social security measures and social insurance schemes, which are helped partly or
wholly from public funds, e.g. oldage pensions, sickness and maternity benefits,
unemployment relief, industrial injury compensation, widows pension etc., improve
distribution by reducing inequality of incomes.
Economic S tabilisation
Business activity in an economy is usually characterised by fluctuations of a cyclical
nature. A boom in the economy may burst and lead to a depression. While during
boom, prices rise beyond the reach of common person, spelling misery. During
depression, employment and production levels fall drastically causing colossal damage.
During depression, when employment, production and national income start
declining, government can undertake compensatory spending. This may imply heavy
public works programmes so that employment and incomes may pick up leading to
economic recovery. During boom, public expenditure should be strictly curtailed,
leading to surplus budgets. During depression, public expenditurepolicy would lead to
heavy outlays on public works; expenditure would thus be in excess of revenues, leading
to deficit budgets. Thus public expenditure, if properly planned and conscientiously
undertaken, will have the favourable effect of raising employment, production and
national income, after pulling the economy ont of depression and thus bringing about
ereater economic stabilitv.
Public Expenditure:
10.4 GROWTH OF PUBLIC EXPENDITURE IN INDIA Theories and Growth
The total expenditure of the Central government has grown from Rs. 529 crore in
1950-51to Rs. 1,19,087crore in 1992-93 (budget estimates) (225 times). Of this revenue
expenditure grew even faster. It went up from 347 crore in 1950-51to Rs. 89,570 crore
in 1992-93(B.E.) (258 times). But capital expenditure grew at a slower rate. It increased
from Rs. 183crore in 1950-51to Rs. 29,517 crore (161 times). It is, however, clear that
the total expenditure of the Central government has grown at a much faster rate than
the growth rate in national income which went up from Rs. 8,938 crore in 1950-51to
Rs. 4,25,672 crore (estimated) in 1991-92 (48 times). One can say, that the total
expenditure has been increasing at a rate about 5 times higher than the growth rate of
national income (Gross National'Product).
The trends of the Central government expenditure seem to support two of the most
widely discussed approaches to the behaviour of public expenditure. First, there has
been an increase in public expenditure that conforms to Wagner's law of increasing
state activity. This is obviously the result of the planned economic development
undertaken in India since 1950-51. Second, there have been several discontinuities in
the trend, suggesting the pressure of Peacocli-Wiseman "displacement effect". As
already stated, this effect hypothesizes that government spending rises by discrete
stages in response to the periodic occurrence of "social upheavals". Some of the
discontinuities in Indian government spending, however, can be attributed to events
that may not qualify as "social upheavals". It has been shown that the "displacement
effect" was a factor responsible for increase in spending during and after the Indo-
, Chinese hostilities of 1962. Other factors are: rehabilitation of displaced persons from
Pakistan, oil price hike in 1973 and the inflation that followed, and Indo-Pak war in
1971.
Another salient feature of the growth of government expenditure is the increase in the
i relative share of revenue expenditure in the total expenditure. This share was 65.5 per
cent in 1950-51. When planning got underway and gathered momentum in the first two
Financial Adminidration decades, revenue expenditure always stood at less than 50 per cent of the total outlay
of the Central government. The balance, over 50 per cent, was accounted for by capital
expenditure. Since the seventies, however, the rate of growth of revenue expenditure
has far exceeded that of capital expenditure. In the eighties, revenue expenditure has
increased at twice the rate of increase in capital expenditure.
',.
Recent Trends: During the two years (1991-92 & 1992-93) (BE) the pace and direction
of expenditure have changed radically. The revenue expenditure in 1991-92 increased
by 13.8 per cent over that in 1990-91 whereas capital expenditure actually declined by
seven per cent. In 1992-93(BE), while the revenue expenditure increased by only seven
per cent (down from 13.8 per cent increase in 1991-921, there was a standstill in respect
of the capital expenditure. There are two reasons responsible for the downward trend
in the rate of increase in government expenditure. Firstly, the fiscal crisis faced by the
country beginning with the year 1990-91, deepened in 1991-92. The government
initiated corrective measures to restore fiscal discipline in the economy. Some of the
key elements in this structural adjustment were containment of non-plan expenditure
including defence expenditure and subsidies. Secondly, the economic philosophy of the
government has undergone a revolutionary change. The investment programme of the
government is no longer aimed at increasing investment in public sector enterprises.
With the iiberalisation of the economy -changes in industrial and trade policy,
financial sector reforms etc., are all aimed at less government intervention rather than
more. Hence, the relative decline in government expenditure. This is every reason to
believe that this trend will continue in the foreseable future.
Check Your Progress 2
Note: i) Use the space given below for your answers.
ii) Check your answers with those given at the end of the unit.
1) Examine the impact of public expenditure on distribution.
11.0 OBJECTIVES
After studying this unit, you should be able to:
explain the concept and objectives of performance budgeting
describe the steps in performance budgeting
discuss the performance budgeting system in India; and
evaluate the performance budgeting system.
11.1 INTRODUCTION
In a planned economy, it is logical to think in terms of budgeting both as the nearest
link in a well-integrated system of planning, programming and budgeting and as a tool
of management. It provides a system of information for decision-making, coordination,
evaluation and control to the appropriate levels of the organisation. During recent
years, there has been a significant increase in public expenditure. Government's.
involvement in the stabilisation of the economy, equitable distribution of wealth,
stimulating forces leading to economic growth and increase in the price levels are some
of the factors that have contributed to the increasing public expenditures.
The increasing public expenditures which brought with them a good deal of complexity,
led to two significant questions:
i) how to control and regulate the increasing public expenditures; and
ii) how to introduce efficiency into the public expenditures.
In this unit an attempt has been made to explain the concept of performance budgeting
and its genesis in Indian administration. A critical review of the system has also been
done in the unit.
As we have discussed in Unit 2 of Block 1 of this course, the financial system of our
country during the British period was characterised by high degree of centralisation,
adh2rence to rigid financial rules and procedures, integration of accounts and audit etc.
After independence, attempts have been made to make the financial administration
performance-oriented, with a view to bringing about efficiency and economy in the
implementation of plans, programmes and activities. Efforts were made to make the
budget an efficient tool of plan implementation. The result has been the introduction
o f the performance budgeting system in the government. We shall discuss in detail
itbout the evolution of performance budgeting system in India in Section 11.4 of this
unit.
Financial Administration Performance budgeting is generally understood as a system of presentation of public
7'
expenditure terms of functions, programmes, performance units, viz. activities1
projects, etc., reflecting primarily, the governmental output and its cost. It is essentially
a process which brings out the total governmental operations through a classification by
functions, programmes and activities. Through suitable narrative statements and
workload data that form an integral part of the presentation, it indicates the work done,
proposed to be done and the cost of carrying these out. The main thrust of performance
budgeting has been on providing output-oriented budget information within a long
range perspective so that resources could be allocated more efficiently and effectively.
Its emphasis is on accomplishment rather than on the means of accomplishment. The
purpose of government expenditure is more important than the object of expenditure
under performance budgeting. Thus performance budgeting is a programme of action
for any given year with specific indicators regarding tasks, the means of achieving them
and the cost of achieving them. It tries to define the physical and financial aspects of
each programme and activity and thereby establish the relationship between output
and inputs. Performance budgeting has to operate within the framework of clearly
defined objectives which are to be achieved through successful implementation of
various programmes and activities undertaken by the concerned agency. Performance
budgeting, therefore, involves the development of more refined management tools,
such as work measurement, performance standards, unit costs, etc.
Objectives: Performance budgeting seeks to:
i) correlate the physical and financial aspects of programmes and activities;
ii) improve budget formulation, review and decision-making at all levels of
management in the government machinery;
iii) facilitate better appreciation and review by the legislature;
iv) make possible more effective performance audit;
v) measure progress towards long-term objectives as envisaged in the plan; and
vi) bring annual budgets and developmental plans together through a common
language.
.. .
A
..........................................................................................................
2) List the objectives of performance budgeting.
..........................................................................................................
3) Describe the budgetary process involved in performance budgeting.
..........................................................................................................
wise classification of activities indicating budgetary and account-heads under which the
funds are provided.
Performance Budget: An output-oriented budget emphasising the accomplishment
rather than means to accomplishment.
Performance Audit: Assessment of the performance of an organisation with a view to
know that the results achieved have been commensurate with the expenditure of
resources.
Work Measurement: It is a method of establishing the time taken by a qualified worker
to carry out a specified job at a defined level of performance.
11.8 REFERENCES
I
12.1 INTRODUCTION
India has been passing through a tight financial position. The budgetary deficit over the
years has been increasing and as a result strict financial control became an urgency. The
Government has taken a number of steps to reduce the budgetary deficit through
control of expenditure. However, it is a well-known fact that financial management can
be toned up through budgetary reforms on the lines of Zero Base Budgeting. Zero Base
Budgeting (ZBB) is a control technique which requires that an organisation while
preparing its budget should not take earlier year's expenditure for granted but should
start afresh. This concept implies that a complete re-examination of the ongoing
programmes and activities should be carried out to assess their continued utility.
In this unit an attempt has been made to explain the concept of Zero Base Budgeting,
its objectives, historical background and the process followed for its implementation. It
also discusses the benefits and problems arising from the implementation of zero base
budgeting.
BUDGETING
Zero Base Budgeting is a management process that provides for systematic
consideration of all programmes and activities in conjunction with the formulation of
budget requests. It is a system whereby each governmental programme, regardless of
whether it is new or existing programme must be justified in its entirety each time a new
budget is formulated. It implies that, in defence of its budget request no department
shall make reference to the level of previous appropriation. The analytical definition of
Peter Sarant holds that "Zero Base Budgeting is a technique which complements and
links the existing planning, budgeting and review process. It identifies alternative and
efficient methods of utilising limited resources in the effective attainment of selected
-
Financial Administration benefits. It is a flexible management approach which provides a credible rationale for
re-allocating resources by focusing on the systematic review and justification of the
funding and performance levels of current programmes or activities."
The objectives of Zero Base Budgeting according to the Department of Expenditure,
Ministry of Finance, Government of India are:
"Zero base budgeting requires identification and sharpening of objectives,
examination of various alternative ways of achieving these objectkes, selecting
the best alternatives through cost-benefit and cost-effectiveness analysis,
prioritisation of objectives and programmes, switching of resources from
programmes with lower priority to those with higher priority and identification
and elimination of programmes which have outlived their utility."
Zero Base Budgeting, thus, is an operating, planning and budgeting process which
requires each manager to justify entire budget requests in detail from scratch, and shifts
the burden of proof to each manager to justify why any money should be spent at all, as
well as how the job can be done better. This approach requires that (i) all activities be
identified in decision packages (or programmes) that relate inputs (costs) with outputs
(benefits), (ii) each one be evaluated by systematic analysis, and (iii) all programmes
be ranked in order of performance.
Zero Base Budgeting aims at achieving a state of affairs whereby the whole of the
budget needs to be justified in order to (a) combat waste and complacency (b) ensure
that the relative tasks and activities remain under constant watch and review alternative
levels of action in each sector periodically.
The concept of zero base budgeting is as old as the concept of budgeting. Since the first
budget of any organisation is always prepared from zero, all the organisations
experience this approach at least once. However, in zero base budgeting the idea is
proposed to experience it year after year i.e. every time the budget for the next period
is prepared. This does not mean that efforts made earlier are not taken into consideration
at all. What it exactly means is that one must re-evaluate all activities to find out the
level to which such activity should be funded; i.e. whether it should be eliminated or
shall be funded at reduced level or increased level or similar level? It shall be
determined by the priorities established by top management and by the availability of
funds.
Thus ZBB helps managements to evaluate the claims on scarce resources in terms of
organisation's objectives and to make trade-offs among current operations,
development needs and profits, and allocate the financial and other scarce resources for
the achievement of the objectives or goals of the organisation.
..........................................................................................................
! 2) Distinguish between ZBB and traditional budgeting.
After the construction of decision packages the next important step is to rank the
decision packages. Ranking is the process of arranging the various service levels
(decision packages) and benefits to be gained from the additional funds to be allocated.
These are ranked in order of priority or decreasing benefits to the organisation. The
process allows management to allocate scarce resources by concentrating on the
following three key questions:
1) Where to spend the money first?
2) How much should be spent in pursuing these goals and objettives?
3) What are the consequences of non-implementing those decision packages which are
not going to be approved?
The ranking is done on an ordinal scale (i.e. lst, 2nd and 3rd etc.) in order of priority.
Because of the huge numbers involved the ranking process takes place at a number of
levels depending on the size, geographical dispersion, levelsof management, volume
of decision packages, unit managers, budget staff o r by ranking committee.
Ranking Process
Top level review
A
Senior level
consolidation
and ranking B~ B2 B3 B4
Middle level
consolidation CI c
2 c
3 c
4 c
5
Preliminary
ranking by "1 "2 "3 "4
"5
managers who
developed it
Each subordinate review level prepares a ranking sheet to submit to thenext higher
review level. This sheet serves primarily as a summary sheet to identify the order of
Financial Administration priority placed on each decision package. Each time a ranking sheet is filled out by the
ranking manager who sends it to the next ranking manager. It serves the following
purposes:
1) It identifies cumulative funding level which helps top management to know whether
the total budget request has exceeded the total available resources or is still below it.
2) It allows top management to decide which package it wants to review in detail.
3) It provides a work sheet to top management to make funding decisions among
several rankings readily, adjust the funding levels etc.
The ZBB can be adopted by any organisation willing to aggressively eliminate its
budgetary deficit. But only managers intimately acquainted with the organisation
culture can make it work effectively. Although the process is ideally suited for cost-
effective planned growth, most managers probably will be initially interested in its
enduring cost-reduction aspects and the capability it provides for responding flexibility ,
to sudden shifts in an operating environment. \
. iv) ZBB promotes the tendency to initiate studies and improvements during the
period of operation as the persons at the helm of affairs know that the process
would be exercised next year and their knowledge and training would enhance
efficiency and cost-effectiveness.
v) ZBB provides for quick budget adjustments during the year. If revenue falls short
in this process, it offers the capability to quickly and rationally modify goals and
expectations to correspond to a realistic and affordable plan of operations.
vi) ZBB ensures greater participation of personnel in formulation and ranking
processes. This helps in promoting level of job satisfaction and thus resulting in
better control and operational efficiency in the organisation.
vii) Zero base budgeting is a flexible tool that can be applied on a selective basis. It
does not have to be applied throughout the entire organisation or even in all the
service departments. Keeping in view the limitations of time, money and persons
available to instal, operate and monitor it the management thus can select priority
areas to which zero base budgeting may be applied.
The benefits of ZBB thus can be summed up as follows:
I
- It eliminates redundant activities and those which are being duplicated.
1 - It identifies low and high priority activities for resource deployment.
- It justifies budget requests on cost-benefit and cost-effectiveness basis.
- It allocates scarce resources rationally.
I - It sharpens and quantifies objectives and formulates alternative methods of
operations.
- It promotes involvement of line managers in budget formulation.
C
Problems in Implementatioo
i) Managementfactors: Whenever any cost control technique like zero base budgeting
is adopted there is resistance from certain individuals and groups having interest in
the organisation. Since goals, objectives and targets are achieved through the
actions of responsible people whose behaviour makes the system work or fail, it is
essential for the organisation to examine the effects of adoption of new techniques
I
on the people and the effects of people on techniques. This is very important for the
adoption of ZBB as it challenges the past practices, methods, performance,
attitudes, habits etc., of the people working in the organisation. As such it becomes
very important for the management to effectively manage its internal organisation
before taking any step towards implementation of the zero base budgeting. Thus
effective management of the organisation is the primary requisite in
implementation of the programme.
ii) ZBB is time consuming and is a more complicated process than the conventional
budgeting. It requires more staff, a great deal of time and effort as compared to
conventional budgeting system. For managers at all levels to understand the system
thoroughly there is need for proper communication system.
iii) ZBB involves voluminous paper work. Each d d s i o n unit is supposed to prepare
decision packages and rjve prover iustification. In government de~artments.
Finnncinl Adminislrntion where there are thousands of programmes and activities, the number of decision
packages may run into several thousands. This is bound to create handling problems
and confusion.
iv) There is no standard formula for identifying the minimum level of funding.
Generally minimum level of funding is identified on arbitrary basis which comes
from top management as budget guidelines. But the viability of this procedure is
questionable.
v) The ranking of decision packages, particularly when the number of such packages
is large, creates a big problem. The ranking may become an unwieldy process.
vi) Zero base budgeting decision and the p v of fixing priorities become a political
nightmare. Conflict may arise on ranking as managers have a tendency to assign a
higher priority, to their own projects.
Problems of ZBB can be summed up as:
i) It challenges the past practices, performance, attitudes, of people.
ii) It requires more time and effort.
iii) Detailed costs and necessary information for decision packages often are not made
available.
iv) It increases paper work to unmanageable proportions.
v) Ranking a large number of decision packages becomes an unwieldy process.
vi) Identifying various levels of funding, particularly the minimum level is a difficult
task.
..........................................................................................................
2) Describe the stages in the implementation of zero base budgeting.
..........................................................................................................
3) What are the benefits of this technique?
LET US SUM UP
The ZBB is a technique which helps in achieving the goals of an organisation through
better resource allocation. It is a system of helping managers at all levels to evaluate in
Zero Base Budgeting
detail the Cost-effectiveness of their operations and specific activities. It permits the
executives to better establish their priorities and allocate scarce resources. Under this
system, new expenditure proposals are to compete on the same footing with the ongoing
expenditure based on their respective merits so as to claim a share of the available
resources. In India ZBB was formally introduced in 1986 but so far it has failed to take
off. It has been implementedin the true sense only in the department of space. For the
rest of the ministries the success is negligible. However, the economic crisis through
which India is passing, makes it imperative that ZBB is implemented in true spirit. In
b
fact the system has failed to take off due to administrative problems.
I
12.9 KEY WORDS
B
..
Deer~lonUnit: It is a distinct segment of an organisation for which budget is prepared.
It is identified on the basis of functions, operations or activities of the organisation.
, Decision m: A document that identifiesand describesfacts about an activity from
every possible angle.
PInnning Rogpmdqj Bodgding System (PPBS): It is a technique for optimising
allocation of fundsin the budget through exercise of proper choice among programmes
which compete for limited resources. This technique requires that the identification of
goals or objectives to be achieved by the organisation be clear and specific. The next
step is to search for alternative programmes for achieving these objectives most .
effectively and at least cost. The costs of each programme should be related to the
corresponding output from them.
Ranking: Procxs of arraaging activities in the order of their priority.
12.10 REFERENCES
Austin Allan, Cheek Logan, 1979. Zero Base Budgeting: A Deckion Package Manual,
Amaclom: New York.
Handa, K.L. 1991. Expenditwe Control and Zero Base Budgeting, Indian Institute of
Finance: New Delhi.
Joshi, P.L. & V.P. Raja, 1988. Techniques of Zero Base Budgeting: Text and Cases,
Himalaya Publishing House: Bombay.
Pyhrr A. Peter;1973. Base Budgeting, John Wiley and Sons: New York.
Sarant Peter C.,1978. L o &irc Budgeting in Public Sector, Westley Publishing
Company: Addison.
Stonica Paul J., 1977.'Zero Base Planning and Budgeting, Don Jones: Home Wood.
13.0 OBJECTIVES
After reading this unit, you should be able to :
state the concepts and classification of tax revenue
discuss the components of non-tax revenue
describe the sharing of receipts with states; and
explain trends in resdrce mobilisation over the years.
13.1 INTRODUCTION
Mobilisation of resources is a sine-qua-non for planned economic development of the
economy. It becomes the means to the attainment of growth. The term resource
mobilisation covers much more than taxation. It covers the income from public
services, public enterprises and public utilities. A development plan, in order to be ,
,uccessful, should accord the highest priority to the generation of sufficient surplus
from the ccrrent revenues of the government, its departmental units and the public
enterprises. As development proceeds and the level of income in the economy rises,
it should be able to mop up additional resources in the form of public borrowings
and small savings. It may also be necessary to resort to deficit financing (about which
we will discuss in detail in Unit 15) primarily to provide money for increasing
transactions in the wake of rising incomes and growing monetisation of the economy.
But at the same time care should be taken to ensure that it does not become
inflationary. Similarly external assistance may be necessary as long as domestic
resources do not prove adequate to finance the developmental programmes.
In this unit, we are concentrating mainly on two sources of revenue-tax and non-tax
for resource mobilisation. The compdnents of tax and non-tax revenue will be
discussed and as an example provisions in regard to Budget of 1991-92 relating to
resource mobilisation will be given.
II 1) What do you understand by direct taxes? State the types of direct taxes levied by
the Union Government.
2) What is Corporation Tax?
..........................................................................................................
3) What do you understand by Wealth tax?
.........................................................................................................
...........................................................................................................
4) Distinguish between specific and ad valorem excise duties.
.........................................................................................................
.........................................................................................................
Table 2
International Financial Institutions
I 1) International
Budget
1990-91
Receipts Discharge Net
Revised
1990-91
Receipts Discharge Net
some other taxes to finance their activities. The important taxes falling in this
category are sales tax, land revenue, state excise duties, entertainment tax etc.
2) Some taxes are levied by the central government but their proceeds are divided
between the centre and the states. Union excise duties and taxes on income other
than agricultural income belong to this category. The basis on which these taxes
are divided between the centre and {he states is recommended by the Finance
Commission.
3) The power to levy and collect certain taxes is vested in the centre, whereas their
revenue proceeds are to be distributed among the states. Estate duty on property
other than agricultural land, duty on railway freights and fares, terminal tax on
goods and passengers carried by railways o r purchase of newspaper and
. . . . - - -.
Though some taxes are levied by the central government, the responsibility to collect
them is on the state government. For instance, stamp duties other than those included
in the Union list and excise duties on drugs and cosmetics have been included in this
category.
There is need for decentralisation of functions for encouraging local initiative, for
securing promptness in decision-making and efficiency in its implementation, and for
allowing for a variety of experiments to suit varying needs, tastes and temperaments
- this is implied in the federal nature of the Constitution which ensures immediate
effective resource mobilisation and maintenance of national perspective.
According to 1991-92 budget, current situation of sharing of receipts with states is as
follows :
Table 3
Tax Revenue
resources. Most of the projects on which the state governments invested capital by
borrowing from the centre are not yielding the desired rate of returns. This calls for
more determined efforts to improve the performance of public sector projects. But
some of the non-plan loans have become dead weight debts which need to be
remitted.
Centre-state financial relations need review and readjustment. States should learn to
live within their means and should exploit their resources fully.
India has done extremely well in terms of tax effort. In 1950-51 when the planning
process was initiated, t h ; ~ a x - ~ e National
t Product (NNP) ratio was as low as 6.4%;
since then it has been risiqg steadily and s t a n d a t 25% (approximately) today. For
a developing country like Itidia which started its development effort with a very low
per capita income and has recorded an extremely modesyrate of growth (i.e. around
1.370 per annum increase in NNP per capita), this record in mobilising tax revenue Sourees of Revenw :
is remarkably good by any standard. In India all the major taxes, except personal Tax and Non-Tar
income tax and land revenue, have recorded buoyancy greater than unity. In recent
years buoyancy of excise duty and sales tax has been as high as 1.51 and 1.41
per cent respectively. This has enabled far greater mobilisation of resources through
taxation. There still remains some scope for raising additional tax revenue in the
country. This can be done if the government decides to show the required political
will to tax agricultural incomes which presently remain outside the taxation net.
I Apart from tax revenue other important aspects of resource mobilisation are
generation of non-tax revenues, restricting of current government expenditure and
raising of surpluses of public sector enterprises.
Additional resource mobilisation measures undertaken in the 1990-91 budget were
expected to yield Rs. 1,790 crore. Out of this Rs. 550 crore were to be raised through
i
direct taxes and Rs. 1240 crore through indirect taxes. The states' share in centre's
additional resource mobilisation after making adjustment for the loss of Rs. 170 crore
on account of concessions in income tax was estimated at Rs. 3 crore.
The Railway Budget for 1990-91 proposed hikes in the rates of goods traffic,
passenger fares, parcel and luggage rates. These proposals are estimated to yield
additional revenue of Rs. 892 crore. ~ e v i s i o h i nthe postal and telecommunication
tariffs were estimated to result in an additional revenue of Rs. 645 crore. The total
additional revenue changes in tax rates, through revisions in railway fares and freights
and through revisions in postal and telecommunication tariffs was thus estimated at
Rs. 3327 crore in 1990-91.
II Net profits (after tax) of central government public enterprises increased substantially
from Rs. 2994 crore in 1988-89 to Rs. 3782 crore in 1989-90. The rate of return, as
I measured by the ratio of net profits to capital employed, rises to 4.5% in 1989-90,
which is the highest achieved in the decade. Howeb~rthe petroleum sector accounted
for the bulk of these profits, i.e. Rs. 2,900 crore out of the total Rs. 3,782 crore in
1989-90. The non-petroleum sector enterprises numbering about 200 contributed a
meagre sum of Rs. 882 crore. While this reflects an improvement over the net profit
of Rs. 430 crore made in 1988-89, the ratio of the net profits to capital employed in
I non-petroleum sector enterprises was only 1.3% in 1989-90. It indicates that there is
a substantial scope for improving the financial performance of non-petroleum central
government public enterprises. The overall working results of Central Government
i public enterprises for the first half of 1990-91showed a net profit of Rs. 481 crore as
against Rs. 1,103 crore during the corresponding period of 1989-90.
The seventh plan envisaged generation of internal resources to the ex'tent of
Rs. 23,013 crore and additional resource mobilisation to the extent of Rs. 11,490
crore at 1984-85 prices for fii~ancingthe plan outlays. Against this during the seventh
plan, the public enterprises have generated gross internal resources of Rs. 37,715
crore at current market prices. About 32% of plan investment in central public
enterprises during the seventh plan was financed by generating net internal resources
- 28% by extra-budgetary resources and 40Yo by the budgetary support.
The outlook on the resource mobilisation front is serious but not unmanageable. The
resource imbalances accumulated over several years cannot be eliminated in a short
period. In the present context soft options have either a limited effect or no effect at
all in the correction of macro-economic imbalances. The measures introduced during
1990-91, which aimed at better revenue collections and containment of public
expenditure have had a limited effect as evidenced by the revised budget deficit which
is estimated to be considerably higher than the budget estimate. It is essential that a
serious effort be made to introduce corrective measures through hard decisions and
difficult choices. Any beginning should aim at strict control over government
expenditure, particularly the revenue and non-plan expenditure, rationalisation of
subsidies so that they are better directed towards the poor and improvement in
revenue collections. Continued effort on the part of the government may provide the
basis for a transition to a sustainable resource regime over the next few years.
Resource Mobilipptioll
1) What are the non tax revenue sources of the union government?
.........................................................................................................
.........................................................................................................
.........................................................................................................
KEY WORDS
Closely held Companies : These are companies in which more than fifty per cent
shares are held by five or less than five persons.
Dividend : It is the share of profits earned from a company, either by the government
or any individual as holder of shares in that company.
Finance Commission : Article 280 of the Indian Constitution provides for the setting
up of Finance Commission once in every five years, to recommend to the President
measures relating to th& distribution of financial resources between the centre and
the states. It is entrusted with the task of distribution between the union and the
states of the net proceeds of the taxes which are to be or may be divided between
them and the allocation between the states of respective shares of such proceeds.
Per capita income : Average income per member of the population of a particular
country.
Special Drawing Rights (SDR's) :It is an international reserve currency system which
was created by the International Monetary Fund (IMF) in 1969. SDR's are used along
with goldand dollars as monetary reserves and accepted and used by any member of
the IMF as a means of payments between central banks in exchange for existing
currencies. SDR's which supplement gold and convertible currencies are created
annually and are apportioned to members according to their (the countries) size,
importance and requirements.
Taxation Enquiry Commission :This Commission was set up in 1953 under the
chairmanship of Dr. John Mathai to review the whole Indian tax structure to make Sourap of Revenue :
it more equitable and sound. Tax and Non-Tax
13.8 REFERENCES
Bhatia, H.L., 1992. Public Finance (Revised Edition), Vikas Publishing House :
New Delhi.
Bishnoi Usha, 1980. Union Taxes in India, Chugh Publications : Allahabad.
Chelliah Raja J. 1969. Fiscal Policy in Under-Developed Cbuntries with special
reference to India, George Allen and Unwim Ltd : London.
Jain, Inu, 1988. Resource Mobilization and Fiscal Policy in India, Deep and Deep
Publications : New Delhi.
Jha, S.M., 1990. Taxation and the Indian Economy, Deep and Deep Publications :
New Delhi.
Lall, G.S., 1969. Financial Administration in India, H.P.J. Kapoor : Delhi.
14.0 OBJECTIVES
After reading this unit you should b e able t o :
explain the meaning of deficit financing
discuss the role of deficit financing as an aid t o financing economic development
describe the relationship between deficit financing and inflation
state the impact of deficit financing on price behaviour in India
point out the advantages and limitations of deficit financing; and
suggest measures to control deficit financing.
14.1 INTRODUCTION
The government is committed t o socio-economic responsibilities for breaking the
vicious circle of poverty and uplifting the economic conditions of the masses and
developing the economy into a self-reliant one. In 1950, it was thought that these
objectives could be achieved through the process of planned economic development.
Throughout the period of planned economic development in the country one basic
problem has been that of mobilisation of resources.
Sources of financing economic development are broadly divided into domestic and
foreign sources. Domestic sources of finance at the disposal of the government consist
of taxation, public borrowing, government savings which include surpluses of public
enterprises and deficit financing. The foreign finances consist of loans, grants and
private investments. All these sources of finance have their social costs and benefits
o n the basis of which an upper limit can be determined for the use of any one method
of financing development. Since the financial requirements of development are
enormous and all various sources have their own limitations, it becomes almost
essential t o make use of all the sources as far as possible. The choice is not between
which one is t o be used but between the various combinations of using all of them.
Thus both the domestic and foreign sources of finance have their own place and
importance in a developing country. It is essential to formulate appropriate policies
for different sources of finance and successful implementation of these policies is
required for achieving the desired objectives of rapid economic development.
Taxation is an old source of government revenue. Not only that, it is also regarded
as the most desirable method of financing public investment in developing countries.
But it is a well known fact that taxation has a narrow coverage in developing countries
and the tax revenuetnational income ratio isnot only low but the increase in this ratio
is also very slow during the process of development.
Public borrowing is considered a better method of collecting public revenue than
taxation (on the one hand government will get sources for development programmes Deficla Financing
and, on the other, conspicuous consumption will be reduced). But it cannot substitute
taxation completely because there are certain limitations to the use of this source of
financing development. Firstly public borrowing depends on the credit worthiness of
the government. Secondly, people do not want to lend to the government because
the rates of interest offered by the government are lower than those offered by the
borrowers in the private sector. And thirdly, if the prices are rising, people will not
be interested in saving and lending because of depreciation in the value of money.
We shall be discussing about public borrowing as a source of resource mobilisation
in detail in the next Unit i.e. 15.
Domestic sources of financing economic development are sure to fall short of the
huge financial requirements for rapid economic development in developing
economies. So external sources of finance have become almost essential for the
developing economy. In spite of the necessity of foreign assistance, it remains only a
subordinate source of financing development in a developing economy. In the early
stages of development a substantial foreign assistance may be needed but gradually
foreign assistance as a percentage of development expenditure goes on diminishing
as the developing nations must learn gradually to become self reliant.
Hence various conventional sources of finance, such as taxation. public borrowing,
having been found to be inadequate, deficit financing has been resorted to for
meeting the resource gap. The idea of resorting to deficit financing for economic
development, which is of relatively recent origin, has remained very controversial.
But there are no two opinions regarding the evil consequences of deficit financing,
when adopted carelessely for capital formation and economic development. But the
problem before the country is to choose between the two evils i.e. to adopt deficit
financing for capital formation and face inflation or to go without development
programmes due to paucity of funds.
In this unit we will discuss the meaning of deficit financing and its role as an aid to
financing ec'onomic development. We shall also highlight the relationship between
deficit financing and inflation and its impact on price behaviour in India. The
advantages and limitations of deficit financing are also dealt with.
There were many other factors like mismanagement of the war economy. excessive
dependence on monsoon, power shortagz, labour strikes, increase in the rates of
commodity taxation, rise in wage rates, black money, rise in the international price
of petroleum products which have been responsible for price rise in India. However,
experience shows that the increase in money supply has led to a rise in prices. There
has been a close relationship between the rate of increase in prices and the rate of
growth in money supply and prices have a tendency to rise to new heights at every
successive increase in money supply resulting from deficit financing.
When deficit financing is inflationary, i t will go against the very purpose for which it
is used because it will simply lead to continuous inflation and no development.
Inflation creates uncertainty, labour unrest, work stoppages and decline in
production because of the demand for higher wages and salarieh to compensate for
higher cost of living. Inflation reduces the real income and the real consumption of
all classes of people in the society except the rich. This is objectionable on grounds
of economic efficiency, labour productivity and social justice. Moreover, there is no
certainty that higher levels of income accruing to profit earners will be invested in1
productive enterprises, for the rich may waste windfall gains in con'spicuous
consumption or indulge in speculative activities. Besides, inflation is a sort of invisible
tax on all incomes and cash balances. Their value is automatically reduced with every
rise in prices. Inflation leads to balance of payments difficulties because due to rising
prices the country loses export market and people prefer imported goods. which
appear cheaper as compared to domestic goods.
Inflation is charged with distorting the pattern of investment and production in the
economy. Inflation is beset with the danger of channelising economic resources into
less urgent and speculative fields where the scope for profits to private enterprises is
Illore and such fields are generally of little importance to the nation. Inflationary
deficit financing increases the administrative expenditure of the government because
whenever government resorts to large doses of deficit financing, it has to neutralise
its effects by sanctioning new dearness allowances, revision of controlled prices.
distribution of essentials through fair price shops, compulsory requisition of
foodstuffs etc. All these measures lead to an increase in the administrative burden of
the government in order to ward off inflation caused by the use of deficit financing.
ii) Safe limit of deficit financing also depends on the nature of government
expenditure for which new money is created, i.e., the purpose of deficit
financing. If the newly created money is used for unproductive purposes, the use
of deficit financing will be inflationary and the safe limit of deficit financing will
be lower than if the newly created money is to be used for industrial development
or for intensive farming.
iii) If the foreign exchange reserves are increasing the scope of using deficit financing
will increase because that way the country will be able to import more goods
which will have deflationary effect.
iv) Time lag between the initial investment and the flow of final products also
determines the safe limit of deficit financing. If this time lag is long, then inflation
will set in from the very initial stage of investment and it will not be possible to
control the rapidly rising prices.
v) Low safe limit of deficit financing is required if the economy consists of large
speculative business community.
vi) If government is not in position to implement successfully its economic policies
accompanying the policy of deficit financing, low safe limit of deficit financing is
prescribed.
vii) If a country is already passing through inflationary phase, low deficit financing is
advised.
viii) If the rate of growth of population is high then low deficit financing is good and
vice versa.
ix) Safe limit deficit financing also depends on a country's tax structure and the
borrowing schemes through which the government can take away at least a
portion of additional incomes thereby reducing the purchasing power with the
public. But all this is not easy in a developing economy where there are rigidities
in the tax system. There is large scale tax evasion so that government is not able
to take away any substantial part of additionalincomes. The country is,
therefore, more prone to inflation and the safe limit of deficit financing is low
In a developing economy, all the aforesaid factors exert their influence
simultaneously. The effect of each factor may be favourable or unfavourable for the
use of deficit financing and sometimes the effects of some factors may counter effect
each other and, thus, be cancelled out. This safe limit of deficit financing will be
different for different countries because conditions vary from country to country. The
safe limit of deficit financing also depends on the measure of popular cooperation
which the government gets and the willingness of the people to submit to austerity.
Even if this limit is calculated, it will go on changing with every change in the
economic conditions of the country. With efforts in the right direction this limit can
be shifted upwards so that a larger amount of deficit financing\ can be resorted to by
a government which is conducive to economic development and not inflation.
2) What do you understand by safe limit of deficit financing? List atleast three
factors affecting safe limit.
3) Discuss a few alternatives to control deficit financing. Deficit Financing
14.11 REFERENCES
Bandhopadhyay Asis, 1978, 'Deficit Financing as a Strategy for Economic
Development', in Commerce Guide.
Chelliah R.J.,1973. 'Significance of Alternative Concepts of Budget Deficit', I . M.F.
Staff Papers.
Jain Inu, 1991. 'Deficit Financing, Money Supply and Price Behaviour in Ivdia',
Finance India, Vol. V. No. 3.
Karadia, V.C., 1979. 'Deficit Financing, Money Supply and Price Behaviour ifiladia',
Indian Journal of Economics.
Tripathy , R.N. & M. Tripathy , 1985. Public Finance and Economic Development in
India, Mittal Publications : Delhi.
15.9 OBJECTIVES
After going through this unit, you should be able t o :
state the meaning and causes of public debt
list various types of public debt
explain the important elements of public debt management
discuss the relationship between public debt, economic dcvclopment and inflation
describe the trends and structure of public debt in India; and
discuss the role of the Reserve Bank of India in public debt management.
15.1 INTRODUCTION
We have discussed in the previous unit on Deficit financing that the problem of
resource mobilisation is causing a concern in present times in achieving a self-reliant
economy. A s said earlier, the government finances its expenditure through
conventional sources like taxes. public borrowing o r printing money. With the
government undertaking programmes of planned economic development on a large
scale, it is not possible to meet the related expenditure either entirely through
taxation o r creation of new money. There is a certain limit beyond which revenue
from taxation cannot be raised as it would affect the level of investment, production
in the country and people's paying capacity. Also financing the programmes through
creation of new money beyond a certain level becomes inflationary. Hence resort to
public borrowing as a method of resource mobilisation has become an increasing
phenomenon in present times. Public borrowing helps in discouraging unproductive
expenditure and diverts the savings of the people for capital formation, financing new
developmental projects etc.
'
In this unit, we shall discuss the meaning of public debt. reasons for resorting to
public borrowing and types of public debt. T h e unit highlights the elements of public #,
debt management, trends and structure of public debt in India and the role of Reserve
Bank of India in public debt management.
.........................................................................................................
.........................................................................................................
.........................................................................................................
Uptil now we have seen only one side of the coin. There is another side to the public
debt i.e., the positive role of public debt in economic development. Both public and
private debts play a positive role in a prosperous and growing economy.'As economy
expands, so does saving. Modern employment-theory and fiscal policy tell us that, if
aggregate demand is to be sustained at a high level of employment, this expanding
volume of saving or its equivalent must be obtained and spent by the consumers,
business houses or government. The process by which savirrg is transferred to
spenders is debt creation. Whenever government issues bonds, since these are highly
liquid and risk free securities, they make an excellent purchase for small and
Resource Moblllsstlon conservative savers. To the extent that the availability of bonds encourage saving,
more resources are freed for investment and economic growth tends to be enhanced,
According to Economic Survey 1991, the outstanding internal and external debt of
Government of India at the end of 1991-92 is estimated to amount to Rs. 3,54,901.12
crore as against Rs. 3,11,059.21 crore at the end of 1990-91 (RE). Out of this total a
public debt, internal debt and other liabilities as on 31st March 1992 was 3,19,778.70
crore and external debt as on 31st March 1992 was of the order of 35,122.42 crore.
A major portion i.e. over four-fifths of the public debt is internal. And if the focus
in the c6ming year should be slashing the budget deficit and not fiscal deficit, it might
grow further and assume alarming proportions. The bulk of the government bonds
are held by Indian citizens and institutions - banks, business houses, insurance
companies, governmental agencies and trust funds - within the Indian economy.
While the internal public debt is a liability for the people (as tax payers), that same
debt is simultan.eously an asset for the people as it is helping in undertaking many
developmental projects. Retirement of the internal debt, therefore, calls for a
gigantic transfer payment whereby Indian individuals and business houses would pay
higher taxes and the government, in turn, would pay out those tax revenue to those
individuals and institutions in the aggregate in redeeming the bonds which they hold.
Although a redistribution of wealth would result from this gigantic financial transfer,
it need not entail any immediate decline in the economy's aggregate wealth or
standard of living. The repayment of the internally held public debt entails no leakage
of purchasing powef from the economy of the country as a whole.
External debt
The economic implications of the external public debt are quite different. India owes
this external public debt to foreign governments, foreign banks and international
lending institutions such as the World Bank and the International Monetary Fund.
External public debt is a liability for the Indian people as tax payers and an asset to
foreign lenders. Therefore, retirement of the external public debt would involve
Publk Debt Maaagtmcnt and
Indian households and business houses paying higher taxes and the government Rde of R r s n e Bank of India
would then pay out these tax receipts to lenders abroad. This obvjously means a
transfer of income and wealth from Indian families and business to foreigners. Thus,
retirement of the external public debt would entail a leakage of real purchasing power
out of the economy and a decline in the standard of living of the Indian people.
According to Economic Survey 1991, India's medium and long-term external debt
consisting of external assistance on government and non government accounts,
external commercial borrowings and International Monetary Fund (IMF) liabilities
amount to Rs. 80,135 crore (about 18% of GDP) at the end of 1989-90, including
outstahding Non-Resident Indian (NRI) deposits. The country's aggregate debt stock
was Rs. 97,966 crore at the end of 1989-90amounting to over 22% of GDP. External
debt obligations have increased more than three times during 1980-91. Growing debt
servicing is a matter of immense concern, as it is eroding the aid inflow drastically.
The compound growth rate of aggregate debt stock from 1980-81to 1989-90has been
20% in iupee terms and 10% in terms of U.S. Dollars.
There has been a notable change in the composition of debt stock. At the beginning
of Sixth Five Year Plan, external debt stock consisted mainly of external assistance
which constituted almost 90% of debt stock. Since then, the share of external
assistance in debt stock has declined to less than 70% in 1989-90. External
commercial borrowing has registered the fastest growth and accounts for 27% of debt
stock in 1989-90.
The declining share of external assistance in inflow of external capital, hardening of
terms of such assistance and rapidly rising rates of interest in the international capital
markets contributed to indulgence in the debt service payments in the late 1980s. In
the latter half of the decade debt stock grew at a compound rate of about 17.5?/0
while the growth in debt service amounted to about 28.5 per cent per annum.
During the decade 1979 and 1989, as a proportion of GNP, external debt rose from
11.9% in 1979 to 24% in 1989. Not only this, the average rate of interest of external
borrowings, which was 2.5% during 1979, rose to 6.4% in 1989. Obviously, it implies
that the loans in recent years have been taken on high interest rates.
World Bank's latest debt tables reveal that India's external debt which stood at $62.50
billion'in 1989 rose to an estimated $70.953 billion in 1990. It shows a rise of 13.5%
during the year and thus India has become the third most indebted country in the
world after Brazil and Mexico. This huge debt burden only underlines the fact that
in future years interest payment burden is likely to be much larger and India may
' have to borrow further to fulfil its debt service obligations or we can say that our
country is in serious debt trap.
India faced a severe resource crunch in 1991 and contacted the IMF for a loan of $5-7
billion besides the loans contacted from other sources so that the country is bailed
out of current foreign exchange crisis. The total debt burden will be in range of $76-78
billion.
The basic factor responsible for debt trap is the deteriorating balance of payment
(BOP) on current account. The deficit in balance of payments on current account
which was of the order of Rs. 2852 crore in 1984-85 has risen to Rs. 10,410 crore in
1988-89.
The purpose of the government's recent exercise of devaluing Indian Rupee in July
'91 was to boost export and reduce imports, so that the trade gap is narrowed dowi.
Although the government has been making serious efforts at promoting exports, all
its efforts are getting a setback by the increasing imports. It is, therefore, imperative
that a screening of imports be ca~riedout and non-essential imports slashed with an
t iron hand. The philosophy of import led growth should be abandoned in favour of
the philosophy of import substitution and self-reliance.
1
To relieve the situation, it became imperative for the country to secure a loan from
the IMFMTorld Bank to tide over the present crisis. There is a need to convert
commercial loans bearing high rates of interest into low interest bearing institutional
loans. Such a rescheduling of loans can help to reduce the debt service burden.
-. . . . A. -
Another short-term measure may be to cajole the NIUs into investing in areas either
.* rL- n- -C.TT-.T 2 .A-
Resource MobUMon
certainly mitigate the present foreign exchange scarcity. Another suggestion is to
permit direct foreign investment by multi-national corporations. But while permitting
foreign private investment, vigilance has to be maintained to ensure that the
investment helps to upgrade our technology and capability of production in the
capital goods sector.
However, devaluation, liberalisation or direct foreign investment cannot succeed
unless domestic economy is improved. The external debt situation cannot be analysed
effectively in isolation from the domestic debt situation. Consequently the policies
aimed at correcting the balance of payment situation have to be linked with economic
reforms to contain the fiscal deficit. There is, therefore, the need for evolving an
overall strategy of development which should help to restore the macroeconomic
balance within the country and also limit our dependence on external debt. Here
comes the role of the Reserve Bank of India in managing public debt.
The Reserve Bank of India is entrusted with the responsibility of imposing credit
control measures from time to time. The Banking Companies (Amendment) Act, 1962
requires the commercial banks to mairitain liquidity ratio of certain percentage of
their time and demand liabilities with the Reserve Bank. This facilitates the
commercial banks to borrow money from the Reserve Bank whenever required. This
Statutory Liquidity Ratio (SLR) was raised from 38% to 38.5% of all demand and
time liabilities of commercial banks. Another method of credit control is through the
system of cash reserves where the commercial banks are required to maintain a
minimum amount of liquid assets with the Reserve Bank of India. This Cash Reserve
Ratio (CRR) was left unchanged at its existing legal maximum of 15% of all net
demand and time liabilities of commercial banks. In times of need, the banks can
borrow from the Reserve Bank of India on the basis of eligible securities.
An important step towards rationalisation of the interest rates structure was taken by
Reserve Bank of India when it introduced a new regime of lending rates for
commercial banks with effect from 22nd September, 1990 and replaced the earlier
programme specific, sector specific and region specific interest rates related to the
size of adyances, except for export credit and the Differential Rate of Interest (DRI)
scheme. The rates of interest were again revised on 9th October, 1991 in view of the
changes made in Budget of 1991. The Reserve Bank of India thus regulates the
banking structure through imposition of such liquidity restrictions regarding credit
supply.
Public Debt Management and
Large public debt imposes constraint upon effective monetary (interest rate) policy. Role of Reserve Bank of India
The basic dilemma is between the government's desire for low interest costs, on the
one hand and the goals of economic stability and growth on the other. More
specifically, during periods of inflation, the monetary authority should restrict money
supply which will raise interest rates and thereby tend to limit spending.
Check Your Progress 2
Note : i) Use the space given below for your answers.
ii) Check your answers with those given at the end of the unit.
1) What do you understand by the process of conversion of public debt?
1 5 . 8 LET US SUM UP
Public borrowing apart from imposition of taxes and deficit financing, is one of the
methods through which resources are mobilised for taking up developmental tasks in
the country. In this unit we have discussed the meaning of public debt, causes for
increasing public debt which include increasing government outlays in public sector
projects, for meeting temporary and Short-term budget deficits etc. There are various
types of public debt which can be categorised broadly into reproductive and
unproductive, voluntary and compulsory, internal and external, short-term and
R W U ~M O ~ O ~ U ~ I I
long-term. We have also discussed the importance of public debt management, its
elements which include refunding, conversion, surplus budget, sinking fund etc. The
unit has also touched upon the aspect of public debt, its impact on economic
development and inflation. There has been significant growth of internal debt from
Rs. 2054 crores in 1950-51 to Rs. 183, 183 crores in 1990-91. Similar is the position
with regard to India's external debt. These aspects relating to trends and structure of
public debt in India have been discussed. The Reserve Bank of India as the central
monetary authority in the country has a very important role to play in public debt
management which has been dealt with in the unit.
15.10 REFERENCES
Bhatia H.L., 1992. Public Finance, Revised Edition, Vikas Publishing House: New
Delhi.
Burman Kiran, 1978. India's Public Debt & Policy Since Independence, Chugh
Publications: Allahabad.
Jain, Inu, 1988. Resource Mobilization and Fiscal Policy in India, Deep & Deep
Publications: New Delhi.
Misra, B., 1980. Economics of Public Finance, Revised Edition, Macmillan: New
Delhi.
Sreekantaradhya, 1972. Public Debt and Economic Development in India. Sterling
Publishers: New Delhi.
Thavaraj, M.J.K., 1978. Financial Administration of India, Sultan Chand & Sons,
New Delhi.
Tripathy R.N. & M. Tripathy, 1985. Public Finance and Economic Development in
India, Mittal Publications: Delhi.
Objectives
Introduction
When to Undertake a Financial Analysis?
How to Value Project Benefits and Costs in a Financial Analysis?
The Cash Flow in the Financial Analysis
Discounting in Project Analysis
Let Us Sum Up
Key Words
References
Answers to Check your Progress Exercises
16.0 OBJECTIVES
After reading this unit, you should be able to:
16.1 INTRODUCTION
Financial appraisal is a method used to evaluate the viability of a proposed
project by assessing the value of net cash flows that result from its
implementation. Financial appraisals differ from economic appraisals in the
scope of their investigation, the range of impacts analysed and the methodology
used. A financial appraisal essentially views investment decisions from the
perspective of the organization undertaking the investment. It therefore measures
only the direct effects on the cash flow of the organisation of an investment
,decision.
market prices and valuations are used in.assessing benefits and costs, instead
of measures such as willingness to pay and opportunity cost;
the discount rate used represents the weighted average cost of debt and equity
capital, rather than the estimated social opportunity cost of capital; and
The discount rate and the cash flows to which it is applied are usually specified
on a nominal basis as the cost of debt and cost of equity are observed only in
nominal terms.
It is obviously very important to know whether the input and output projections
given by the proposing firm or agency are valued in current prices (normal) or
constant prices (real). This is necessary to ensure that the analysis is carried out
in a consistent set of prices, so that the total net value of the project ultimately
I calculated is a real figure.
Often, constant (say 1990) prices, rather thin current prices, are used in a
project's cash flow. A project's cash flow is merely the costs and benefits paid
and produced by the project over its lifetime in the years that they occur. The use
of constant prices simplifies the analysis, as it relieves the analyst of the need to
make projections about the anticipated inflation rate in the country over the life
of the project. This procedure is quite appropriate if input and output prices in
domestic currency are expected to increase at approximately the same rate over
the life of the project.
However, there are several situations where the use of constant prices may not be
appropriate. The first is when the analyst is drawing up project financing plans.
In this situation, the analyst will need to estimate expenditures in nominal terms
to ensure that planned sources of finance will be sufficient to cover all project
costs. The second is a situation where the investment is privately operated and
will pay company tax. The financial analysis will need to be carried out in both
nominal and real terms because the rate of inflation will affect the interest
payments, depreciation allowance and the cost of holding stocks. All these will
influence the firm's tax liability. Working capital requirements will also be
affected by the level of inflation. Finally, if input prices are expected to rise at
different rates over the life of the project, and vary from year to year, it will
usually be simpler to include all prices in current terms.
li interest.
, In the case of project outputs, they should therefore be valued at the market price
received for them at the project gate. Transport costs from the project to market
should be subtracted from the wholesale price received in the market. Project
inputs should also be valued at their market cost at the project gate. This price
will include the transport and handling cost of getting them there.
II Many a times project appraisals split costs (and sometimes benefits) between
locally incurred and foreign exchange costs and benefits. This is useful if policy
Investment of Public Funds makers wish to judge the impact of the project on the balance payments, or if
foreign financing agents such as aid agencies or multilateral banks wish to see
the distribution of items eligible for aid grants or loans.
Usually, even if local and foreign costs are identified, in a financial analysis all
costs and benefits are then expressed in local currency, converted at the official
exchange rate. However, the foreign currency costs may in some instances be
expressed in a common international currency like US Dollar, or in terms of the
local currency of a bilateral aid donor country.
In order to separate the cash flow into local and foreign prices, and also to predict
the future price of a project's tradable inputs and outputs, it may be necessary to
make projections about future exchange rates. To do this it will be necessary to
assess, inter alia, if local inflation rates are likely to diverge from average
international inflation rates, and particularly those of the host country's major
trading patterns. If local inflation is expected to be higher than the average for
major trading partners, devaluation of the local currency could be anticipated,
increasing both the costs of imported inputs and the local currency value of
exported outputs. If local inflation is expected to be lower than that of the
country's major trading partners, it is likely that the local currency will
appreciate over the life of the project. If this is a real appreciation, it will have the
effect of lowering imported input prices as well as lowering the local currency
receipts from exported outputs and/or reducing the international competitiveness
of these exports.
The following section paragraphs discusses about how the inputs and outputs of a
project that are valued in market prices should be incorporated into a project's
cash flow in order to undertake a financial analysis.
Financial Appraisal
16.4 THE CASH FLOW IN THE FINANCIAL
ANALYSIS
Project Life
Capital Costs
The capital costs of a project can be divided into fixed capital costs, or the cost of
acquiring fixed assets like plant and equipment, start-up costs, and working
capital, which finances the operating expenses of the enterprise. In a financial
analysis, all forms of capital expenditure should be entered in the financial cash
flow in the years in which the project actually has to pay for them. For example,
if the project receives a soft loan from the supplier of its equipment, which
involves a grace period before repaying the loan, the cost of this equipment will
not be included in the cash flow until it must be paid for by the project.
Operating Costs
The project's operating costs cover its recurrent outlays on labour services
(wages and salaries), raw materials, energy, utilities (water, waste removal, etc,),
marketing, transport, insurance, taxes and debt service over the life of the project.
Each operating cost is entered in the cash flow in the year (month or quarter) in
which it is incurred. Total operating costs may also be expressed in terms of
costs per unit of output. As was mentioned previously, unit operating costs are
likely to be somewhat higher in the first year or two of a project, so the
difference between start-up costs under capital costs, and steady state operating
Investment of Public Funds Treatment of Taxes
The taxable income of the project will be determined by subtracting all operating
costs, interest payments and allowable depreciation on the capital assets from the
firm's revenue earnings each year. The appropriate company income tax rate is
then applied to this taxable income to determine the project's taxation liability.
If the country gives incentives to new investments in the form of tax holidays or
accelerated depreciation of assets, these should be taken into account in the
project's taxable income and tax liability. The tax liability is subtracted from
taxable income to obtain the project's net of tax income.
Project Benefits
In a financial analysis, the project's benefits equal the cash receipts actually
received by the project from the sate of goods or services it produces, or the
market value equivalent of home consumed output in the case of non-marketed
output. This can be the revenue fi-om sales, rent or royalties, depending on the
nature of the project. Other revenue earned from, for example, bank deposits, the
sale of fixed assets or insurance claims, will also be included as separate items
under project receipts or benefits.
a Net Benefits
The project's net benefit stream is calculated as the difference between the total
revenue (or benefit) stream and its expenditure (costs) stream.
For example, suppose the project is expected to yield a stream of benefits equal
to BO, Bl, B2, .... Bn and to incur a stream of costs equal to CO, C1, C2,. .... Cn
in years 0, 1,2, ... n. Then in each period the net benefits (benefits minus costs)
of the project will be:
-
(BO-CO), (B 1-C I), (B2-C2), ... (Bn-Cn)
This is simply the project's net benefit flow.
Assuming that the discount rate, r, is constant, then the discounted cash flow of
the project can be represented as:
The net present value criterion of a project is the single most important measure
of the project's worth. If a project's NPV is positive (i.e. its discounted benefits
exceed its discounted costs), then the project should be accepted. If its NPV is
negative (its discounted costs exceed its discounted benefits), then the project
I should be rejected.
I
In the above table, an 8% discount rate is used to mechanically discount the net
benefits of a railway project. The project's NPV can then be estimated by just
adding up these discounted net benefits. Columns (I), (2) and (3) show the non-
discounted costs, benefits and net benefits (benefits-costs) of the railway project.
I Column (4) gives the discount factor, 1/(1+.08)t, by which the non-discounted
i
net benefits in column (3) are multiplied, to obtain the discounted value of these
i net benefits in each year, t, shown in column (5). These discounted net benefits
I can then be added together to obtain the total discounted net benefits, or net
present value, of the project.
The bottom line of the table shows that the NPV comes to $L10.4 million if an
8%.discount rate is used. A NPV greater than zero indicates that the discounted
benefits of the project are expected to be greater than its discounted costs and the
project will therefore be worth undertaking.
This example illustrates how crucially the estimation of a project's NPV depends
on the discount rate employed. A lower discount rate would have deflated future
income by less and increased NPV of the project. A higher discount rate would
have deflated future income more heavily and decreased the NPV of the project,
Investment of Public Funds possibly changing it from positive to negative. The selection of the appropriate
discount rate is therefore a very important issue in project appraisal.
In a financial analysis market prices are used to value project inputs and outputs,
even if these prices are distorted. Market prices are used so that the financial
profitability of the project to its implementer can be determined. The market
price of capital to the project implementer is the market interest rate, and this
represents the cost to the implementer of investing capital in the project. The
correct approach to determining the financial discount rate, the discount rate used
in the financial analysis, is therefore to estimate the actual cost of capital to the
project implementer This will vary depending on whether at the margin the
implementer is a borrower or lender of investible funds.
If the project implementer is a net borrower, the interest rate at which the
enterprise can borrow is the opportunity cost of funds employed. This market
borrowing rate should be used as the financial discount rate for any project
appraisal undertaken by the enterprise. If the project implementer intends to draw
some funds from its own financial resources and some from market borrowings,
the weighted cost of the capital it obtains from these different sources will be the
appropriate financial discount rate.
If the firm or the government Considering a project is a net lender, in the absence
of the project it could invest these funds in the financial market and earn the
market lending rate. The opportunity cost of the funds to be used for the project
will therefore be the after tax market lending rate that it could earn on this
capital. The project must earn at least this market lending rate for it to be worth
doing and the after- tax lending rate should therefore be used as the financial
discount rate for any project appraisals undertaken by this enterprise. In reality
the enterprise will usually want to earn some margin above the market lending
rate if the project is considered a riskier use of the firm's funds than available
financial investments.
The two most commonly used discounted measures of a project's net benefit are
its net present value and internal rate of return. The domestic resource cost ratio,
benefit cost ratio and net benefit investment ratio are also be discussed below:
The NPV measure of project worth is the most useful and one of the most
commonly used criteria for determining whether a project should be
accepted.The net present value of a project is simply the present value, PV, of its
net benefit stream. It is obtained by discounting the stream of net benefits
produced by the project over its lifetime, back to its value in the chosen base
period, usually the present. The net present value formula is:
Where,
The internal rate of return, IRR, of a project is probably the most commonly used
assessment criterion in project appraisal. This is primarily because the concept of
an IRR is in some ways comparable to the profit rate of a project and is therefore
easy for non-economists to understand. Furthermore, it does not rely on the
selection of a predetermined discount rate.
The internal rate of return is the discount rate that, if used to discount a project's
costs and benefits, will just make the project's net present value equal to zero.
Thus the internal rate of return is the discount rate, r*, at which:
Since the internal rate of return is the discount rate internal to the project, its
calculation does not depend on prior selection of a discount rate. A project's
internal rate of return can therefore be thought of as the discount rate at which it
would be just worthwhile doing the project. For a financial analysis, it would be
the maximum interest rate that the project could afford to pay on its funds and
still recover all its investment and operating costs.
A project is potentially worthwhile if the IRR is greater than the test discount
rate. If projects are mutually exclusive, this rule would suggest that the project
with the highest IRR should be chosen.
The net benefit investment ratio, NBIR, is the most convenient selection criterion
to use when there is a single period budget constraint.
NBIR'of a project is the ratio of the present value of the project's benefits, net of
operating costs, to the present value of its investment cost. Its formula is given
by:
2
Where
/ The NBIR therefore shows the value of the project's discounted benefits, net of
Investment of Public Funds The decision rule for the net benefit investment ratio is that all projects that have
a net benefit investment ratio greater than unity should be selected. This selection
criterion is completely compatible with those for the net present value and the
internal rate of return of a project.
The benefit cost ratio was the earliest discounted project assessment criterion to
be employed. However, due to problems associated with its applied use, it is
rarely used in project appraisal today.
The benefit cost ratio is simply the ratio of the sum of the project's discounted
benefits to the sum of its discounted investment and operating costs. This can be
expressed mathematically as:
A project should be accepted if its BCR is greater than or equal to 1, that is, if its
discounted benefits exceed its discounted costs.
- - - -
16.8 REFERENCES
Dasgupta, A.K. and Pearce, D.W., 1972, Cost-Benefit Analysis-Theory and
Practice, Macmillan, London.
Layard, R (ed.), 1972, Cost-Benefit Analysis, Penguin, Harmonsworth.
Little, I.M.D. and Mirrlees, J.A., 1990. Project Appraisal and Planning for
Developing Countries, Heinemann Educational Books, London.
Pearce, D.W. and Nash, C.A., 1981. The Social Appraisal of Projects: A Text in
Cost Benefit Analysis, Macmillan, London.
Perkins, Frances. 1952, Practical Cost-Benefit Analysis: Basic Concepts and
Applications, Macmillan, Australia.
Squire, L. and Van der Tak, H.G., 1975, Economic Analysis of Projects, Johns
Hopkins University Press, Baltimore.
UNIDO, 1972. Guidelinesfor Project Evaluation, United Nations, New York.
The NPV measure of project worth is the most useful and one of the
most commonly used criteria for determining whether a project should
be accepted.
The net present value of a project is simply the present value, PV, of
its net benefit stream. It is obtained by discounting the stream of net
benefits produced by the project over its lifetime, back to its value in
the chosen base period, usually the present. The net present value
formula is:
17.0 OBJECTIVES
After reading this unit, you should be able to:
17.1 INTRODUCTION
An economic analysis, also called a cost benefit analysis, is an extension of a
financial analysis. An economic analysis is employed mainly by governments
and international agencies to determine whether or not particular projects or
policies will improve a community's welfare and should therefore be supported.
As cost benefit analysis enables the analyst to determine if a project will make a
positive contribution to the welfare of a country, it should routinely be
undertaken to evaluate major government-funded projects and policies. The
government should also undertake a cost benefit analysis of any private project
seeking government subsidies or policy support, such as tariff protection.
The methodology of cost benefit analysis, or CBA, was first developed in the
1930s in the United States when the Federal government had to decide whether
to undertake many large, publicly funded irrigation, hydroelectricity and water
supply projects in the dry central and western states of the United States.
However, modem cost benefit analysis theory and practice h e evolved largely
from path-breaking work by Little and Mirrlees, Dasgupta, Marglin and Sen in
their UNIDO Guidelines, Harberger , Corden , Squire and Van Der Tak and
other work collected in Layard . Many other useful contributions have been made
by various authors.
When a cost benefi analysis is undertaken, micro economic, macro economic and
international trade theory is applied to real world situations in order to answer
questions such as these:
Should a new bridge be built, or should the existing ferry service be Economic and Social
Appraisal
upgraded?
Should an export-oriented aluminum refinery be established, or should the
unprocessed bauxite and coal be exported?
Should computers be imported or assembled locally?
Will this irrigation project be a better use of resources and lead to a greater
increase in community welfare than that highway project?
What fuel should be used to generate electricity?
For the government to answer these questions, it is necessary that it goes beyond
a financial appraisal, which determines how commercially profitable these
alternative policies and potential investments would be. This is essential for a
number of reasons. The first is that governments typically have broader and more
complex objectives, which they wish to achieve from public gdod and social
service provision and policymaking generally, than mere profit maximisation. If
governments only wished to maximise profits from the operation of state
enterprises, they would be well advised to privatise them, as the private sector is
likely to be more efficient at pursuing this goal. Government objectives fall
broadly under the heading of "optimisation of community welfare". The most
straightforward economic objective is the optimisation of the level of GNP per
capita. Other objectives may include preserving the environment, redistributing
income to particular target groups or regions and enhancing national security.
Even from this short list it is obvious that there may be conflict between some of
these objectives. One of the major reasons that governments use cost benefit
analysis is to determine the impact of various competing projects on community
welfare, defined in terms of all these different criteria.
The other major reason for the use of cost benefit analysis lies in the many
distortions and imperfections that affect prices in factor and goods markets. In
many countries market prices, that is, prices quoted in domestic markets, reflect a
range of distortions, including taxes, subsidies, controlled prices, tariffs, and
monopoly or monopsony rents. These factors distort market prices so that they
no longer reflect the true economic value that people place on consuming such
goods and services (their demand price), or the true cost to the economy of
producing them (their supply price). If a government wishes to determine which
projects will make a positive contribution to community welfare, it will not
necessarily be able to use the market prices of the projects' inputs and outputs to
calculate their true costs and benefits to society.
When undertaking a cost benefit analysis, the project analyst will try to correct for
such distortions by calculating economic, or shadow, prices. The shadow prices of
the project's inputs and outputs, like labour and capital, goods that enter
international trade, traded goods, and those that do not, non-traded goods, will
reflect the true economic value of these inputs and outputs to the economy
concerned. In a cost benefit analysis shadow prices for projects' inputs and outputs
are substituted for market prices.
This process yields the basis concept of the project and background information,
which enables the government to progress to the pre-feasibility study stage.
Pre-feasibility Study
Using this preliminary data, financial and economic analyses of the project will
. then be undertaken by the economic analyst, to determine whether the project
appears to be financially and economically viable. A preliminary financing
schedule may also be drawn up to identi@ the source and costs of funds. If the
project appears viable from this preliminary investigation, it will be worthwhile
proceeding to the full feasibility study stage.
Feasibility Study
At this stage, more accurate data must be obtained on all project costs and
benefits, but particularly those that risk analysis indicates are crucial to the
project's viability. The financial and economic viability of the project is then
assessed again. If the project is still found to be viable, approval should be sought
to proceed to the project design phase.
Project Design
Implementation
At this stage, tenders are let and contracts signed to facilitate the appointment of
the project manager, who will oversee the construction and possibly the
operation of the project.
Ex-post Evaluation Economic and Social
Appraisal
Financial analysis whether used in the public or the private sector, implies the
notion of the agency maximising its net financial surplus over time. This will
generally differ from the maximisation of the economic surplus generated for the
community as a whole whenever prices do not reflect the benefits or costs
associated with an activity (in some case there may not even be any prices
because benefits and costs are not traded).
In the case of the more commercial agencies the differences between financial
appraisal and economic evaluation will commonly be comparatively small.
However for agencies with significant community service obligations, fmancial
appraisal can be suitably applied only in a narrow range of decision choices.
Thus in the economic evaluation of a public road not subject to a toll, financial
appraisal will not be of much assistance. Similarly, in choosing between two sites
for a hospital, not only should the costs of building on the two sites be
Investment of Public Funds considered, but also the level of transport costs and length of travel time incurred
by patients and visitors to the hospital.
Thus in estimating the economic costs and benefits of a project, the analyst
will have to estimate values where no direct price is charged and will
generally have to consider a wider range of costs and benefits than occurs
in a financial appraisal.
Definition Objectives: The starting point and in many ways the most crucial
aspect for the evaluation of an investment proposal is the specification of the
objectives of the proposal and their relation'to the overall objectives of the
agency. No appraisal of the project can be meaningful unless the objectives
are clearly defined.
new asset of comparable standard to that being replaced. In the case of an Economic and Social
expansion of activities the base case would represent a continuation of the Appraisal
existing system or policies.
Second, the analysis should include all impacts, both beneficial and otherwise, of
the proposal being evaluated. In particular, not only should the intended effects
or benefits which are the objectives of the project be included, but also the
subsidiary or indirect effects.
There are a range of types of benefits and costs which must be considered, and
they accrue to different people: some accrue directly to the user or provider of
the service; while others accrue to outsiders (these are known as externalities).
The case of the evaluation of a dam whose primary purpose is the provision of
irrigation for commercial crops can be used as an example. The impacts to be
included in the analysis would be:
the provision of irrigation water for cropping (the rrimary objective and a
traded benefit);
the provision of urban water (a traded benefit)
flood mitigation benefits (a quantifiable non-traded benefit which is external
to the users and providers of water);
recreational benefits offered by the dam (a quantifiable non- traded benefit
external to the consumers of water); and
environmental effects on native flora and fauna (an external effect which
may be difficult to quantify even in physical terms).
When considering benefits and costs which either cannot be valued or cannot be
quantified there can be a tendency to concentrate on the benefits and ignore the
costs. This should be resisted.
Where the services are bought and sold it is generally presumed that the price
paid is a reasonable proxy for the values of the service to the consumer. This
principle will hold most closely where the changes in output and price levels
associated with the investment are relatively small. Where output changes
are significant then it may be desirable to take account of changes in
consumer surplus (an excess over the market price which the consumer
would have been willing to pay). This will require knowledge of the price
elasticity of demand (i.e. sensitivity of demand to changes in price).
However, where the service is not freely traded or there is no price charged,
or where the benefits fall broadly on the community rather than individual
users, more indirect measures of the willingness to pay for the benefits need
to be derived. A variety of techniques are available including:
1
i) the use of data on expenditure by consumers in seeking to participate in
benefits (e.g. costs incurred in visiting a national park);
I
ii) price data from related goods and services (e.g. variations in house prices Economic and Social
due to the impact of noise levels to assess the cost of airport noise); and Appraisal
Some government services have been provided at subsidised prices and this
introduces distortions in the market. Therefore the imposition of customer
charges to value benefits is likely to understate benefits. As with services for
which no price is charged, additional effort is needed in the appraisal to
estimate the additional benefits, either from externalities or consumer
surplus.
Specific Issues
b) Treatment of Inflation
Due to inflation, costs and benefits which occur later will be higher in
cash terms than similar costs or benefits which occur earlier.
.There are two different ways to tackle this issue. Either nominal values
can be used for each time period and then discounted with a nominal
discount rate, or real cash flows can be used discounted by a real
discount rate. In practice it is considered that the use of real cash flows
and discount rates may simplify the forecasting and calculation
processes.
ii) Labour
iii) Overheads
At the end of the planning horizon or project life, some assets may
still have some value. Such assets may not have reached the end of
their economic life and may still be of use to the agency or may be
resale able. In this case the value of an asset may be assessed at a
level pro rata to its remaining economic life. Alternatively the asset
may have reached the end of its economic life but have a scrap
value. This value is a benefit to the project and should,be included in
the evaluation. Certain assets are nondepreciable, such as land and
can be valued at opportunity cost.
a) Sunk Costs
b) Depreciation
c) Interest
The costs and benefits flowing from an investment decision are spread
over time. Initial investment costs are borne up front while benefits or
operating zcosts may extend far into the future. Even in the absence of
inflation, a rupee received now is worth more than a rupee received at
some time in the future. Conversely, a rupee's cost incurred now is more
onerous than a rupee's cost accruing at some future time. This reflects the
concept of timze preference which can be seen in the fact that people
normally prefer to receive cash sooner rather than later and pay bills later
rather than sooner. The existence of real interest rates reflects this time
preference.
The first two concepts of the discount rate relate to the opportunity cost
of the resources used in the public sector investment projects. Resources
could be used elsewhere and the discount rate attempts to measure such
opportunities foregone. In principle the social time preference rate and
the opportunity cost of capital should be the same. However, for various
reasons such as private sector profit and capital constraints in the public
sector, the two will differ. Typically the opportunity cost of capital will
be greater than the social time preference rate.
Investment of Public Funds Resources devoted to public investment will be at the expense of current
consumption or private sector investment. In a growing economy with
rising living standards, a rupee's consumption today will be more valued
than a rupee's consumption at some future time for, in the latter case, the
rupee will be subtracted from a higher income level. This so-called
marginal social rate of time preference is, of course, not easy to
measure.
Similarly in the case when net benefits are spread far into the future, the
higher the discount rate, the more net benefits far in the future are
downgraded in present value terms relative to net benefits closer to hand.
Thus, short lived options are favoured by higher discount rates relative to
long-lived options.
d) Decision Criteria
Once all the costs and benefits over the life of the programme have been
identified and quantified, they are expressed in present value terms.
Using the discounted stream of costs and benefits, the following decision
measures should be calculated. Investment decision making is primarily
concerned with three types of processes:
The screening process, whereby the decision maker, faced with a Economic and Social
range of independent projects and adequate resources, must accept or Appraisal
reject the individual projects.
The choice process between mutually exclusive projects, whereby
the decision makers must choose from a range of mutually exclusive
projects (commonly directed at similar objectives):
The ranking process, whereby the decision maker is faced with
resource constraints which prevent all acceptable projects from being
preceded with- hence the projects must be ranked in an objective
manner.
Net Present Value is the sum of the discounted project benefits less
discounted project costs. Formally it can be expressed as follows:
Under this decision rule, a project is potentially worthwhile (or viable) if the
NPV is greater than zero; ie the total discounted value of benefits is greater
than the total discounted costs. If projects are mutually exclusive, the project
which yields the highest NPV would be chosen.
The Benefit-Cost Ratio (BCR) is the ratio of the present value of benefits to
the present value of costs. In algebraic terms it can be expressed as follows:
1-0 (1 r)"
+ "-0 (1+ r)"
It has become conventional to split costs into two types when calculating
BCRs: initial capital costs and ongoing costs. Ongoing costs are normally
deducted from benefits in the year incurred to make a net benefit stream,
while initial capital costs are used as the denominator.
The Internal Rate of Return (IRR) is the discount rate at which the net
present value of a project is equal to zero, ie discounted benefits equal
Investment of Public Funds discounted costs. In algebraic terms the IRR is the value of r which solves
the equation:
A project is potentially worthwhile if the IRR is greater than the test discount
rate. If projects are mutually exclusive, this rule would suggest that the
project with the highest IRR should be chosen.
The NPV and BCR provide equally acceptable criteria for showing whether
an individual project is worthwhile, when taken in isolation. Both clearly
show when, for a given discount rate, the project benefits exceed costs and
the results of the rules will not conflict with each other.
While in many cases the IRR will also yield simple and unambiguous results,
care needs to be exercised in the use of IRR. In cases of non-conventional
cost-benefit streams (i.e. where there are substantial discontinuities or breaks
in the net benefits stream over time) more than one quite different IRR may
be calculated. An example of a non-conventional cost-benefit stream is
where a project incurs net costs initially followed by net benefits over a
number of years and then net costs again.
A simple use of NPV, BCR and IRR will not yield the same results for the
more complex choice between mutually exclusive projects. The project with
the highest NPV may not have the highest IRR or the highest BCR. In the
latter case this is because the ratio can be affected by the inclusion of costs as
negative benefits, or different balances between initial costs and ongoing
costs. This makes it difficult to compare across projects.
None of the three decision criteria discussed above take capital constraints
explicitly into account, although the BCR calculation as indicated above
implicitly does so. However, use of the NPV per rupee of total capital would
result in the choice of that combination of projects which maximizes the total
30 NPV obtained from a limited capital works budget.
It can be readily calculated as follows: Economic and Social
Appraisal
Note that the capital investment is discounted to its present value in the same
way as are the net benefits.
Using this measure, projects with the highest NPV per dollar of total capital
are selected until the budget is exhausted.
This means that the expenditure constraint may be a factor in the choice of
an investment option which does not have the highest NPV, if the option
with the highest NPV requires very high expenditure. In such circumstances
the return on the incremental expenditure may be relatively low. This
procedure seeks to maximize aggregate NPV from the available funds.
Sensitivity Analysis
ii) Determine relationships between the sensitivities for the various variables
(e.g. nominal wages and inflation). If correlations exist these may be tackled
by:
Post-Implementation Review
iii) examination of the project design and implementation to assess the scope
for improvement to the option adopted.
By examining these issues ex post evaluations will assist in the development and
evaluation of future projects.
Distributional Weights
One of the most commonly used methods of undertaking a social cost benefit
analysis is to introduce distributional weights in to the cash flow. Distributional
weights are attached to changes in income, costs and benefits, received by
different income groups, ensuring that a project's impact on the income of low
income groups receives a higher weight than the same dollar impact on the
income of high income groups. The introduction of these distributional weights
enables projects to be assessed on the basis of distributional as well as efficiency
objectives.
In the example shown below the government of a country with a highly skewed
income distribution is considering two mutually exclusive projects, A and B.
Table 1
The Use of Distributional Weights in Social Analysis of Projects ($L Million)
Project A Project B
Cost paid by
Benefits received by
If distributional weights, d: 1 1 1 1 1
Economic NPV +50 +80
Therefore do Project B
I
If distributional weights, d: 2 1 2 1
There are several problems for analyst wishing to use this approach. The first is
the difficulty of tracing the net income changes accruing to different income
groups as a result of the project, even in the case of relatively straightforward
project. It may be very time consuming and expensive to identify who will bear
the costs of a project, who will reap its benefits; and what the income levels of
these different groups are. It has therefore been argued that the introduction of
distributional issues into project appraisal will so increase the complexity of
undertaking a cost benefit analysis that serious inaccuracies could become more
common. This argument is very persuasive and may be conclusive for large
projects with a diverse group of beneficiaries and whose income levels may be
difficult to determine. The counter argument put by those supporting social
analysis of projects is that, as distributional:issues will be implicitly introduced
into project analysis in any case, it is much better that they are treated in a
consistent and rigorous way.
The second problem with the use of distributional weights relates to how the
government or project analyst can objectively determine the appropriate set of
weights to employ. Even if the distributional impacts of a large project can be
traced, the marginal utility of income of these different groups may be very hard
to determine.
Economists such as Harberger and Amin have opposed the formal inclusion of
distributional objectives into cost benefit analysis. They claim that, by
necessitating comparisons of the welfare that individuals receive from increasing
their income by a fixed amount, say $1, social cost benefit analysis compromises
the objectivity of project appraisal. Instead, Jenkins and Harberger recommend
merely documenting which groups benefit and which lose from a project, leaving
it to decision-makers to determine implicit, rather than explicit, distributional
weights.
Supporters of social benefit analysis argue that failure to explicitly compare the
utility received by different income groups within the framework of the project
appraisal implies that the analyst gives equal weight to gains in consumption by
all income groups, from the poorest and most destitute to the wealthiest groups in
society. This would only be justified if it were assumed that the marginal
utility of income, the change in utility experienced from a given increase in
consumption, of all individuals was equal irrespective of their income levels.
17.8 REFERENCES
Amin, G.A.,1978, Project Appraisal and Income Distributional Weights in
Social Cost Benefit Analysis, World development, 6.
Corden,W .M., 1974, Trade Policy and Economic Welfare, Oxford University
press, London.
Harberger, A.C., 1972, Project Evaluation, Collected Papers, Macmillan, New York.
Layard, R. (Ed), 1972, Cost Benefit Analysis, Penguin, Harmonsworth.
Little, I.M.D. and Mirrlees, J.A.,1974, Project Appraisal and Planning for
Developing Countries, Heinemann Educational Books, London.
Squire, L. and Van der Tak, H.G.,1975, Economic Analysis of Projects, Johns
Hopkins University Press, Baltimore.
UNIDO, 1972, Guidelinesfor Project Evaluation, United Nations, New York.
-
In public sector the fundamental requirement is for an economic
appraisal.
The financial analysis will show the demand on cash flow which will
result from the project an important factor when managing the states
finances. The financial analysis will also show the rate of return from the
project which is important for commercial agencies.
18.0 OBJECTIVES
18.1 INTRODUCTION
Financial administration of a country is executed through (a) the legislature, (b) the
Executive, (c) the Finance ~ e p a r t m e n t(d)
, the Audit and (e) the Parliamentary
committees. Legislature is the on1.y competent organ of government in democracies
which authorises the government to collect taxes and also t o spend them in a
particular manner. Without legislative approval neither the amounts can be
appropriated nor taxes collected. It can also abolish or decrease or levy taxes. In
theory !i. is the executive which demands and the legislature approves. Therefore,
. before the government can work on its budget plan, it has to get it passed by the
Parliament. This is known as enactment of the budget.
The discussion on the budget in Parliament provides the members with opportunity
to review, the working of various Departments and Ministries. It also enables them
to elicit information on the progress achieved in the implementation of various
programmes undertaken by the Government. The members get an opportunity of.
examining the worthwhileness and the social and economic implications of the new
expenditure proposals included in the budget.
The Comptroller and Auditor General of India-a statutory authority under the
Constitution-acts as a watch dog of the Parliament and conducts audit to see that
Financial Control the expenditure incurred by the Executive is for the purpose voted by the
Parliament and is within the sanctioned grants. The cases of default, financial
irregularities misappropriation of funds and neglect of financial propriety are
reported by the Comptroller and Auditor General of India to the Public Accounts
Committee for such action as it may deem necessary. While examining the
appropriation of accounts and the reports of the Comptroller and Auditor General
of India thereon, the Committee conducts an elaborate system of investigations.
The review of the Audit Report by the Public Accounts Committee completes the
cycle of Parliamentary financial control over appropriation grants to the Executive.
.
The entire administrative machinery comes under the potential control of the
legislature. This is because every action may provide a question; every question, an
adjournment debate, and 'every adjournment debate a fulldress debate'. Besides,
the Parliamentary Committees too, exercise control over the Government of the
day.
rates of existing taxes, for the withdrawal of money from the Consolidated Fund
for public expenditure. and for raising of loans. Public Accounts are scrutinised by
the Public Accounts Committee and are audited by a statutory authority which is
independent of the executive: In Indian context, the following four principles of
financial controi are being followed:
' i) The executive, acting through Ministers cannot raise money by taxation,
borrowing or otherwise without the authority of Parliament; proposals for
expenditure requiring additional funds must emanate from the cabinet.
ii) The second principle is the Control that vests in the Lok Sabha which has the
exclusive control of the Money bills. These must orginate in the Lok Sabha
which has the sole power to grant money by way of taxes or loans and to
authorise expenditure. The Rajya Sabha may reject a grant but not add to it.
iii) The demand for grants must come from the Government. Neither the Lok
Sabha nor a State Assembly may vote a grant except on a demand for grant
from the Government.
iv) Likewise, the proposal for a new tax or for an increase in the rate of an existing
tax must come from the Government.
In India the instruments of legislative control are: Questions, Adjournment
motions, Resolutions, Votes, ~ u d ~ e tand
s , Legislative Committees-Public
Accounts Committee, Estimates Committee, Committee on subordinate legislation
and the Committee on Assurances. These tools of exercising legislative control are
described here briefly.
1) Question Hour :The first hour of every Parliamentary day is reserved for
questions, which provide an effective form of control. Questions asked can keep the
entire administration on its toes. A question is an effective device of focusing public
attention, in a striking manner, on different aspects of administration's policies and
activities. Any administrative action can provoke a question, though the member
cannot compel the Minister to give the answer. The Speaker, too, may disallow
certain questions. A question is asked with a view to getting information, obtaining
ministerial opinion on a subject or simply hammering the government on alleged
weak points. Many of the questions, may be trivial, but some d o cause tremendous
harm to the Government-the Life Insurance Corporation episode of 1956 resulting
in the resignation of Finance Minister arose from an answer t o a question.
a) After the presentation of the budget, general discussion takes place. On -this
occasion the discussion relates to the budget as a whole o r any question of
principles involved therein.
b) Voting on grants provides the second opportuni'ty. Discussion at this stage is
confined to each head of the Demand, and, if cut motions are moved to the
specific points raised therein, the discussion is sufficiently pointed and may be
focused on specific points.
i) the extent to which such assurances, promises etc., have been implemented and
ii) where implemented, whether such implementation has taken place within the
minimum time necessary for the purpose. The existence of such a committee make4
Ministers more careful in making promises.
Though full legislative control over the budget is a concept of this countly,
historically the concept of budget began to develop in the late middle ages when the
revenue was to be collected from the king's domain. Hence the budget was a
statement of revenue and expenditure. During the wars and other emergencies when
the King required a lot of money for running the affairs of the state, he had t o
consult the nobility to know their views on the taxes. The expenditure still remained
a prerogative of the king. Only after the 1688 revolution, the Principle of 'No
revenue without representation' got established. The control over expenditure had
still not acquired the conventions of legislative approval.
.The system of legislative control over Public finance first arose in England and it
was more a growth t h a ~ ai creation. The first step that waslaken in this direction
during the reign of King John was towards the control of receipts and revenues .
rather that of expenditure. The Stuart autocracy made the Parliamentarians more
exacting and they began to claim a share in the control of Public expenditure as
well. But this did not come'about suddenly or according t o any concerted plan or
design it was a very gradual development.
The establishment of the accounting and reporting system in 1787, the audit system
under the Exchequer and Audit Department Act of 1866, and the constitution of a
Standing Committee of Public Accounts in the House of Commons in 1866 were
significant historical developments in the arena of Legislative Control.
Thus was built up the modern system of Audit and Report through which the
Legislature controls the finances of the state. The system of legislative control in
India is more or less based on the system prevailing, in England.
The Constitution of India provides in its various articles the legislative procedure
and procedure in financial matters. The main provisions of Indian Constitution are
given below:
1 As per Article 107 (i) subject to the provisions of Articles 109 and 117 with respect Legislative Control
I to Money Bills and other financial bills, a bill may orginate in either House of
I Parliament and subject to the provisions of Articles 108 and 109 a Bill shall not be
I
deemed to have been passed by the House of Parliament unless it has been agreed
I
to by both Houses, either without amendment or with such amendments only as are
agreed to by both Houses.
Article 109 (1) provides that a Money Bill shall not be introduced in the Council of
States. As,per Article 109 (2), after a Money Bill has been passed by the House of
the People ;it shall be transmitied to the Council of States for its recommendations
I and the council of States shall within a period of fourteen days from the date of its
receipt of the Bill return the Bill to the House of the People with its recommenda-
tions and the House of the people may there upon either accept or reject all or any
of the recommendation of the Council of State's. As per Article 109 (3), if the House
of the People accepts any of the recommendations of the Council of States, the
t Money Bill shall be deemed to have been passed by both the Houses with the
amendments recommended by the Council of State and accepted by the House of
the People.
Article 112 (1) provides that the President shall in respect of every financial year
cause'to belaid before both the Houses of the Parliament statement of the
estimated receipts and expenditure of the Government of India for the year. Such a
statement is called "Annual Financial Statement".
As per Article 113 (1). so much of the estimate as related t o the expenditure charged
u t o n the Consolidated Fund of India shall not be submitted to the vote of the
Parliament. Butpothing in this clause shall be construed as preventing the
. . discussion in either House of Parliament of any of those estimates.
Article 114 (1) provides that as soon as the grants under Article 113 have been made
by the House of the People, there shall be introduced a Bill t o provide for the
appropriation out of the Consolidated Fund of lndia of all moneys required to
meet:
a) the grants so made by the House of the People, and
b) the expenditure charged on the Consolidated Fund of India but not exceeding
, in any case the amount shown in the statement previously laid before
Parliament.
As per Article 116 (I), the House of the People shall have power:
a) to make any grant in advance in respect of the estimated expenditure for a part
of any financial year pending the completion of the procedure prescribed in
Article 113 for the voting of such grant and the passing of the law in accordance
with the provisions of Article 114 in relation to that expenditure.
b) to make a grant' for meeting an unexpected demand upon the resources of India
when on account of the magnitude or the indefinite character of the Service, the
demand cannot be stated with the detail ordinarily given in an annual financial
statement;
c) to make an exceptional grant which forms no part of the current service of any
financial year, and the Parliament shall hiive power to authorise by law the
withdrawal of moneys from the Consolidated Fund of India for purposes for
which the said grants are made.
As per Article 117 (1) A BiJl or amendment making provision for any of the matters
specified under Article 110 shall not be introduced:,or moved except on the
recommendation, of the President and a Bill making such provision shall not be
introduced in the Council of States. No such recommendation shall be required for
mo~ng an amkndment making provision for reduction or abolition of any tax.
Article 117 (b) also provides that a Bill which, if enacted and brought into
operation, would involve expenditure from the Consolidated Fund of India shall
not be passed by either House of Parliament unless the President has recommended
t o that House the consideration of the Bill.
t inancial Control ( hpck Your Progress 2
- - - --
18.5 CONTROL OVER TAXATION -
Legislation of the Budget is by no means complete until a provision has been made
for collecting the required money from the people. For this purpose a ~ i n a n c ; Hill
is placed before the House. This bill embodies the taxation or revenue proposals for
the financial year that is, it includes all the existing taxation schemes with
modification or without modification.
This practice is quite in consonance with the well known principle of democracy
that "no tax shall be levied or collected except by authority of law". as embodied in
Article 265 of our Constitution. S o while the passage of the Appropriation Bill
authorises the Government t o appropriate money from the Consolidated Fund, the
passage of the Finance Bill authorises it t o collect taxes.
The Finance Bill is the bil). embodying the Government's Financial (Taxation)
prbposals for the ensuing financial year which has t o be passed by the Parliament
every year. It is open t o general and clause by clause discussion. Amendments may
propose the abolition or the reduction of any'tax but may not propose new tax or
an increase in the rate of any existing tax. The Bill as amended I \ passed by the Lok
Sabha and after consideration by the Rajya Sabha it goes to I he President for his
signature after which it becomes an Act.
A Money Bill, however, differs from the Finance Bill in the following respects:
b) A Money Bill is a Bill certified to be such by the Speaker of the Lok Sabha
- . - ...
c) - A Money Bill must be returned by the Rajya Sabha to the Lok Sabha within Legislative Control
14 days of its receipt with its recommendations. if any, which the Lok Sabha is
not bound to accept. Disagreement over a Finance Bill.however, is resolved at a
joint sitting by a majority of the total number of members present and voting.
The function of the legislature does not end with the voting of grants for public
expenditure. Is has also to see that the funds granted are spent faithfully and
economically according to its direction. The Parliament has to satisfy itself that the
(1) funds have been applied to purposes approved (2) within the amounts
appropriated and (3) that waste and extrayagance have been avoided. For this
purpose, there is an independent audit of all the departmental accounts by the
Comptroller and Auditor General of India followed by an examination of his report
by a Parliamentary sub Committee.
Since the Parliament is too unwieldy a body for a serious technical discussion on
the.C.A.G.'s'reports, it sends the reports for detailed examination to certain
committees of the Parliament. Some important committees of this type are
discussed below:
3) examine whether the money is well-laid out within the limits of the policy
implied in the estimates, .
4) suggest the forms in which the estimates shall be presented to the Parliament.
The Committee selects some departments each year, examines their working in
great detail and makes the suggestions on organisations, economy etc. including
policy matters.
transferred t o it. After examinatidn of the report, COPU sends it to the Parliament
alongwith its own comments. The reports of this committee alongwith C.A.G.'s
reports provide a very effective instrument of control of Parliament over Public
expenditure.
Hence from the foregoing discussion it is clear that the Parliament sanction funds
to Government for spending but it takes appropriate steps t o see that:
18.7. LET U S S U M UP
Even if the budget proposals of the Government are not normally modified by the
Parliament the budgetary process gives the members a number of opportunities t o
discuss the policy of the Government. During the general discussion on the budget
the members can criticise the general policy of the Government and can suggest
alternatives. During discussion over the grants of different departments, the
Parliament can examine in detail the working of particular departments and make
suggestions about improving their working. Similarly opportunities are also
provided by discussions on the Appropriation Bill and the Finance Bill.
KEY WORDS
Finance Bill : The Finance Bill is the Bill embodying the Government's Financial
(Taxation) proposals for the ensuing financial year which has t o be passed by
Parliament every year. It has a broader coverage in that it deals with other matters
well.
Financial Control expenditure. A ~ o n e yBill is a Bill certified t o be such by the Speaker of the Lok
Sabha.
19.0 OBJECTIVES
The term financial administration is used in a broad sense to include all the
processes involved in collecting, budgeting, appropriating and expending public
money, auditing income and expenditures, auditing receipts and disbursements;
accounting for assets and liabilities and accounting for the financial transactions of
the government and reporting upon income and expenditures, reporting upon
receipts and disbursements, and the condition's 'of funds and appropriations.
Government like any other organisation, can achieve little without finance.
Therefore, the efficiency of financial administration is an important aspect of
Government's effectiveness. A government which has worked out a satisfactory
system of financial administration has gone a long way towards putting the
administration of its affairs upon an efficient basis.
In financial administration , legislature plays the key rok. All other agencies of
financial administration act on behalf of the legislature, and are responsible to the
legislature for all their activities. Hence legislative control over the finances and
financial administration of the country is direct and pervasive.
In order to exercise proper control, the Parliament and legislature setup certain
committees. Three such committees set up in India, namely, Estimates Committee,
Public Accounts ~ o m m i t k eand the Committee on Public Undertakings, which
exercise financial control on behalf of the legislature. The purpose of financial
control is to secure honesty and economy in expenditure. These agencies have to see
that the tax payers money is rightly and properly used.
Historically, the Webly commission of 1896 indicated the need for an accounts
committee to highlight financial irregularities. The Montague Chelmsford reforms
suggested the creation of such committees out of the provincial legislatures.
The first such committee on Public Accounts was created at the centre to deal with
the appropriation of ~ c c o u n t sof the Governor General in Council and the report
of the Auditor General thereon. The British Parliament acquired power to grant
appropriation with the Revolution of 1688. The power to ascertain how the money
had been spent was conferred only in 1861, when the House of Commons created
the committe on Public Accounts.
In India, the Public Accounts Committee was first created at the centre in 1923 with
the coming into force of the Montford reforms in 1921. It became a major force in
the legislative control of Public expenditure. Despite the limitations of its
constitution and the restrictions on its authority, it exercised erlormous influence in
bringing to bear upon government the need to enforce economy in the expknditure
of public money.
committee of Parliament, called the Public Accounts Committee. A committee of System of Financial Committees
Parliament is preferred because the Parliament does not have the time to undertake
detailed examination of the report. Secondly, the scrutlny being technical, can best
be done by a committee and, lastly. the non-party character of the examination is
possible only in a committee but not in the house.
Composition
Under the provisions of the Constitution, the Public Accounts Committee at the
Centre is constituted of members from both the Houses of Parliament; it is
composed of 22 members, 15 &om the Lok Sabha and 7 from the Rajya Sabha. The
members are elected through a system of proportional representation by single
transferable vote. Almost every sizeable party or group is represented on the
Committee. Although the committee is elected annually, there is a convention that
there should be a two year tenure of the membership to ensure continuity. The
Chairman of the Committee is nominated by the Speaker from amongst the
members of the Committee. Till 1966-67, the chairman belonged to the ruling party.
Since then, a member of the opposition has been named the chairman.
a) the moneys shown in the accounts as having been disbursed were legally
available for and applicable to the service or purpose to which they have been
applied or charged;
a) to examine, in the light of the report of the Comptroller and Auditor General,
the Statement of accounts showing the income and expenditure of state
corporations, trading and manufacturing schemes and projects, together with
the balance sheets and statements of Profit and Loss accounts which the
President may have required to be prepared, or are prepared, under the
provisions of the statutory rules regulating the financing of a particular
corporation, trading concern, or project;
The committee also reviews the form and details in which the estimates are
prepared in order to arrest any tendency t o reduce the number of votes or to
include large lump-sum provisions since these are regarded as diminishing the
control of Parliament over the estimates. It goes into the technical accounting
procedure, in order to find out its adequacy or otherwise to control departmental
extravagance.
The Committee may send for persons, papers and records. The conclusions of the
Committee are submitted to Parliament in the form of a report. T o make the work
of the committee more effictive, the Comptroller and Auditor General now submits
interim reports to it. The committee is thus able to reach the conclusions and
finalise its recommendations. It has at its disposal the services of the Comptroller
and Auditor General. who is the guide. vhilosovher and friend of the committee.
A convention has evolved that the recommendations of the Committee are accepted
by the Government. But sometimes these arc sent back for reconsideration Mo\t 01
the issues are thus settled through mutual diseussion and free and frank exchanrc o f
views.
The Public Accounts Committee probes into the transactions carried out It
conducts a post-mortem examination of the Public Accounts. To quote the first
Speaker of the Lok S a W a (inlhe speeches and writings of G.V. Matalan har.
Speaker t o PAC, p. 97)-'The very fact of consciousness that there is someone wh
will scrutinize what has been done. is a great check on the slackness or ncgiigence oJ
the executive." The examination, if it is properly carried out. thus. leads to general
efficiency of the administration. The examination by the committee may also be
useful as a guide for both future estimates and policies
ESTIMATES COMMITTEE
.. The Estimates Committee was first created in April, 1950 and its functions were
enlarged in 1953. There had been a predecessor or Estimates Committee. called the
Standing Finance Committee, which was first constituted in 1921 and attached to
the Finance Department of the Government of India. This committee depended on
the will of the executive. It had no statutory status. Its functions were not clearly
defined and its deliberations were not satisfying to the elected representatives of the
legislative assembly.
Composition
The Estimates Committee, constituted in 1950 had 25 members; in 1956 the
. .
membership was revised t o 30. It is a select committee elected by the members of'
the Lok Sabha from amongst themselves according to the principle of
proportionate representation based on single transferable vote. The term of office
of the menibers is one year. But according to conventions, two-thirds of the
members are re-elected for another year. The Chairman of the Committee is
nominated by the Speaker. If, however, the Deputy Speaker is a member of the
Committee he automatically becomes the Chairman. Ministers cannot be system of Financial Committees
appointed on the Estimates Committee. Its functions, methods'of appointments and
other relevant matters are laid down in the Rules of Procedure and conducting of
Business in the Lok Sabha.
Functions
The committee examines such of the estimates as it may deem fit or are specifically
referred to it by the Lok Sabha o r the Speaker to:
i) report what economies, improvements in organisation, efficiency and
administrative refoims, consistent with the policy undkrlying the estimates, may
be affected;
ii) suggest alternative policies in order to bring out efficiency and economy in
administration;
iii) examine whether the money is well laid out within the limits of policy implied
k in the estimates; and
I iv) suggest the form in which the estimates shall be presented to the Parliament.
! While examining the policies of the government the Estimates Committee does not
lay down tny policy. It can only see whether the policies laid down by Parliament
are carried out. The basic functions of the committee are to ensure efficiency and
economy in administration. The Estimates Committee can constitute one or more
. sub-committees. The reports of the sub-committees are deemed to be the reports of
the whole committee.
...................................................................
...................................................................
.....................................................................
2) Evaluate.the functioning of Estimates Committee in India.
.......................................................................
.......................................................................
.......................................................................
.......................... ............................................
Till April 1964 the affairs of Public Enterprises in India used t o be looked after by
the two Committees: namely the Estimates Committee and Public Accounts
Committee. But in view of huge investments and manifold increase in the activities
of public enterprises it was felt that there should be a separate agency which should
look into the working of public enterprises in detail and report to the Parliament.
Composition
Earlier there used to be ]%members in the Committee, with 10 members from the
Lok Sabha and 5 members from the Rajya Sabha. With effect from April 1974, the
number of members has been increased to 22 ....15 members of COPU are drawn
from the Lok Sabha and 7 members are drawn from the Rajya Sabha. The
.
members of COPU are elected every year in accordance with the principles of
proportional representation by means of single transferable vote.
Functions of COPU
The Principal functions of COPU are:
a) to examine the reports and accounts of Public Undertakings as specified in the
fourth schedule of the Rules of procedure and conduct of Business in Lok
Sabha;
b) to examine the reports, if any, of the Comptroller a n d ' ~ u d i t o General
r of India
on the Public Undertakings;
c) to examine, in the context of autonomy and efficiency of the public
undertakings, whether the affairs'of the Public Undertakings are being
managed in accordance with sound business principles and prudent commercial
practice;
d) to exercise such other functions vested in the Public Accounts Committee and
the Estimates Committee in relation t o the Public Undertakings as are not
covered by clauses (a), (b) and (c) above and as may be allotted to the
committee from time t o time.
The COPU shall not examine:
i) Matters of major Government policy as distinct from business or commercial
functions of Public enterprises;
ii) matters of day-to-day administration,
;i;l m s t t m r c fnr r n m c i r l m r s t i n n fnr w h i r h m s r h i n m r v i c s l r m s A v e c t s h l i c h m r l hv r n v
special statute under which a particular Public Enterprises is established. System of Financial ('ommittee\
The Committee asks the ministry and the enterprises to fivnish necessary material
relating to chosen subjects. The committee often visits chosen enterprises for
informal discussions. After the study tours, and after receiving formal
memorandum and other information from concerned parties, non-official and
official witnesses are invited to give evidence at formal sittings of the committee
held at Parliament House. .All evidence given before the Committee is treated as
confidential.
A thorough examination of working of the public enterprises by the COPU is the best
available device of control over these enterprises by the Parliament. The COPU keeps
the Parliament duly informed about their performance and how monies voted by rt
are, intact, appropriated. Through the COPU the administration comes in direct
contact with the Parliament. The COPU has done some usefyl work. In its tone.
temper and manner of working, it is not different from the Estimates Comm~ttee-and
the Public Accounts Committee. But the advantage lies in the fact that it ha< been
able to give sufficient time to the study of Public Undertakings because it is concerned
exclusively with them. In the course of examination of causes and investigat~onof
problems and issues the Committee has, from time to time, made some specific
suggestions to the government and they have been found to be quite useful. It has,
hence, contributed towards improving the performance and profitability of the\e
enterprises.
.......................................................................
2) What are the weaknesses of parliamentary financial control in India?
.......................................................................
, 1 9 3 KEY WORDS
19.9 REFERENCES
I
AggarwaIa, R.N. 1966. Financial Committees of Indian Parliament, S. Chand and
Co., Delhi.
Bhambri, C.P. 1959. Parliamentary Control over Finances in India, Jai Prakash
Nath: Meerut.
Chanda, Asok, 1959. Indian Administration, George Allen and Unwin: London.
Gadhok, D.N. 1976. Parliamentary Control over Government Expenditure, Sterling
Publishers Pvt. Ltd. Delhi:
Morris, Jones 1957. Parliament in India, London.
Plowden Committee Report, 1961. Control over Public Expenditure.
Prem Chand, A. 1961. Parliamentary Control over Expenditure-How to make it
effective.Economic and Political Weekly.
Ramanathan, V.V. 1964. Control o f Public Enterprises in India. Asia Publishing
House: Delhi.
Thavaraj, M.J.K. 1964. "Essential of financial Administration", Indian Journal of
Public Administration.
Wattal, P.K. 1963. Parliamentary Financial Control in India. Minerva Book Shop:
Bombay.
.
19.10 ANSWERS TO CHECK YOUR PROGRESS
EXERCISES
In India, the Public Accounts Committee was first created at the Centre in
1923.
Parliamentary control over finances of the government is assured through a
special Committee of Parliament, called Public Accounts Committee.
A Committee of Parliament is preferred because the Parliament does not
. have the time to undertake a detailed examination of the report.
The Scrutiny being tedhnical, can best be done by a Committee.
The non-party character of the examination is possible only in a Committee
Financial Control 2) Your answer should include the following points:
The functions of the Committee is t o satisfy itself that
money shown in the accounts as having been disbursed were legally availabe
for and applicable t o the service o r purpose t o which they have been applied
o r charged.
expenditure conforms t o the authority which governs it.
every reappropriation has been made in accordance with provlslons framed
by the competent authority.
I t shall also be the duty of the Committee.
t o examine, in the light of the report of the Comptroller and Auditor
General.
t o examine the statements of accounts showing the income and expenditure
of autonomous and Semi autonomous bodies.
20.0 OBJECTIVES
briefly sketch the progress made towards delegation of financial powers and
analyse the vario_us problems in financial delegation.
INTRODUCTION
In order to ensure proper financial control, both the legislature and the executive
have to play an important role. Legislature has to determine by law the sources of
government revenue; whereas Executive has to provide the machinery and lay down
thd procedure for the collection of revenue. Executive control is one of the most
important instruments of financial administration. Control in matters of policy
concerning finance vests in the government as a whole. Government decides the
policy of expenditure. Questions like pay, pension and provident fund to the
officials are all determined by the government. The executive performs the policy-
making function concerning finance, and then it is subject to the approval of the
legislature. The Finance Department is always responsible for the entire financial
administration of the country. The department performs a variety of functions with
----- 4
. ------
* - c: -c *L.. . -..-*--.
With,the emergence of new tasks after Independence and the launching elf Five-Ykar Executive Control
Plans, the implementation of the various programmes of economic ind sqcial
,development placed larger responsibilities on the administrative authorities and
executing agencies. In order to achieve their goals realistically efficiently and
economically the operating agencies need adequate facilities. Their prime requirement
is control of their financial resources. This is only possible through delegation bf
financial powers.
The broad functions and structure of finance department at the centre and in the
states have remained more or less the same even after Independence. Legislative
control over the executive, especially in financial matters, is sought to be achieved
through (1) its approval of the detailed expenditure and tax proposals and (2) as well
as through its scrutiny of executive's irresponsibility and irregularities committed in
the course of impiementation of the budgets. The formal aspect of accountability to
the legislature requires that the executive conducts its affairs in such a way that it is
not exposed to adverse criticism. Hence the executive as well as the top layers of the
administrative hierarchy are interested in exercising such control over the various
levels of administration to prevent irregularities and ensure efficiency and economy in
operations.
It is the control at the first and the third stages that generally engages much of the
time of the Finance Ministrv and that im~ineeson the dav-to-dav workinn of the 79
Financial Control administrative ministries. A 'control at these stages, if too rigid or detailed involving
much time and effort,'can slow down the pace of work, delay the implementation of
projects-particularly developmental, commercial or industrial and thereby cause loss
of national effort or income. While the need for control or scrutiny is n i t denied, ~t
must be constructive, purposeful, imaginahve and not narrow in outlpok or cramping
in effect.
The Executive control could be exercised when the estimates are prepared or when
expenditure is incurred. The units of a department are not generally interested, except
in the most incidental or indireci way in the general financial problems of the service
or of the government or of the economy as a whole. Their main interest lies in their
work. It becomes necessary that the head of various services should scrutinise
estimates in terms of their needs and spending capacity. This process moves upwards
to heads of departments who are expected to moderate the estimates in the light of .
accepted policies of the government. Under a cabinet system, The Treasury is
entrusted with the responsibility to aggregate and consolidate the estimates of the
different departments. In discharging this function the Treasury may be able to
influence the departmenial estimates through scrutiny and advice.
The Finance Department controls and coordinates various spending departnients. The
framing of general financial and economic policies and programmes of Government is
the responsibility of the Finance Department. The Finance ~ e ~ a r t m eprepares
nt the
estimates of income and expenditure and submits them to the Parliament for
approval. After the Parliament has approved the Budget, the Finance Department
plays the most important part in theaexecution of tbe Budget. Thus it is.a department
of control and supervision whose main duty is to manage the finances of the state.
Grants are voted and appropriations are made by the Parliament to the executive. It
is the duty of the executive to spend the money as voted by the Parliament. The
maxims of honesty, efficiency, and economy should guide the conduct of the
Executive officials while they spend public money. Parliament is the sole authority
'
under the Constitution empowered to sanction funds to the executive for all
expenditures. It is the duty of the Parliament to ensure that an adequate machinery
exists to see that no money is spent out of the consolidated funds by the executive
beyond the appropriations provided by law or the Parliament.
Under the traditional system, the Treasury, down to the heads of the units, assumes
responsibility for the efficient and economical expenditure of the funds entrusted to
them as soon as the budget is approved by the fund-granting authority. But in the
modern times financial administration defines budgetary control as the establishment
of departmental budgets ;elating to the responsibilities of executives, to the require-
ments of a policy and the continuous comparison of actuals with budgeted results.
This comparison aims at securing, through individual or collective action, the
objectives of the policy or to provide a basis for its revision.
Tlhe Finance Department of the government exercises great control over items of
expenditure pertaining to estimates which have been approved by the Parliament, and
for which resources have been duly appropriated. The finance department is always
responsible for the entire financial administration of the country. The department
performs a variety of functions with regard to finance of the country. It has control
over expenditure of money. It controls and coordinates various spending departments
of the government. It is responsible for the collection of taxes. 1t.exercises vital
control and supervision over the expenditure of the government departments.
Check 'Your ~ r o g i e s s1 ,
The Budget division of the Department of Economic Affairs is responsible for the
preparation and presentation to Parliament the Budget of the Central Government.
This division performs the whole function of coordination, collection and
consolidation of data relating to receipts and expenditure of Government. The
Internal Finance divisi6n is concerned with all matters connected with currency and
coinage, Reserve Bank of India, Price control etc. The Planning division is concerned
with the work connected with the preparation of the capital Budget and the allocation
of ceilings of capital expenditure of the various ministries. External Finance division
is responsible for matters relating to foreign exchange, budget foreign investments etc.
The Economic division is an advisory wing of the department of Economic Affairs. Its
main function is to examine trends in the economy and to carry out studies and
research with a view to advising the Ministry on questions of economic developments
abroad, particularly those which have a bearing on the Indian economy. Insurance
division deals with the administration of the Life Insurance Corporation.
The Banking wing of the Department of Revenue and Banking is concerned with the
formulation and implementation of Government policies having a bearing on the
commercial banks and long-term financial institutions excluding LIC and UTI.
he Department of Expenditure
The department of expenditure is divided into the following divisions:
The scrutiny of expenditure by Ministry of Finance after Budget has been approved
by the Parliament is due to the fact that often Administrative Ministries submit their
schemes to the Finance Ministry during the last moments of the preparation of
the estimates. There is generally inadequate prebudget scrutiny for want of'
details in the case of @any schemes. Since often schemes are included in the Budget
without prior scrutiny it becomes necessary for the Ministry of Finance to undertab
the examination after the Budget has been approved and before they are actually
executed. Therefore, unless the expenditure sanctions are issued with the concurrence
of the Finance Ministry, no part of the expenditure can be incurred. To avoid such a
delay, prebudget scrutiny of the schemes by the administrative ministries and the
Finance Ministry should be complete and detailed.
.......................................................................
2) Critically analyse the role of the Ministry of Finance.
..--
20.4 DELEGATION OF FINANCIAL POWER
Financial Control respect of creation of.posts and contingent expenditure. These powers were further
enhanced in 1954 and 1955. A.K. Chanda, the then Comptroller and Auditor General
of India, who undertook the task of preparing a plan for delegation of financial
powers and for a reorganisation of the system of financial control, submitted his
proposals for the consideration of the Public Accounts Committee gf Parliament
While pinpointing the defects in the existing system, he recommended that, to avoid
delays in the issue of expenditure sanction$, the particulars of the proposals referred
by the adniinistrative ministry to the Ministry of Finance at the prebudget review
stage should be furnished in greater detail to enable the Finance Ministry to carry out
a better and more systematic prebudget scrutiny. A breakthrough, of key importance,
came in 1958, when the Government of India sought to delegate financial powers to
the administrative Ministries.
The Government has recognised the need for rationalising the procedures for
expenditure sanctions and delegation of powers to the administrative ministries in .
their various delegation schemes. The main objectives of these delegation schemes has
been to improve the procedure for prebudget scrutiny and to delegate within broad
limits powers of post-budget expenditure sanctions to the administrative departments
The Estimates Committee in its Ninetyeighth report in 1975-76 observed that there is
a need for further redelegation of powers t o the field agencies which have the primary
responsibility for execution of schemes and attaining set targets. The Committee
endorsed the view that it is essential that they should have adequate powers
commensurate with the responsibilities to be discharged by them. The Committee
suggested that one of the ways to ensure that delegated powers are actually exercised
is to create proper atmosphere to it. The officers should be consciously encouraged to
develop initiative and take decisions. It should also be ensured that methodical and
conscious work and exercise of powers entrusted to officers is recognised and
appreciated while bonafide ommissions and commissions are not held against them.
"If the project is to be implemented without delay, the need for delegating some
powers to the administrative ministries for incurring expenditure on the essential
preliminary items becomes important. It is, therefore, suggested that after the
preliminary feasibility report has been examined and approved by the government,
the administrative ministries should have powers to incur expenditure within certain
limits on the essential preparatory items pertaining the project."
UMer the latest delegatiqn schemes the administrative ministries have W n given full
powers of reappropriation within a grant, provided there'is no diversion of funds
from plan schemes to non-plan activities and there is no augmentation of the total
proyision made for administrative expenses under a particular grant. In actual
practice. the administrative ministries,enjoy enough freedom in the matter of
reappropriation of funds, even in these cases where reappropriation of funds could,
under the rules. be done only withthe prior sanction of the Ministry of Finance.
2 ) Discuss the observation of Estates Commjttee, ARC on the need for delegation of
financial powers.
20.5 LET U S S U M U P
I rom time to time the Government has recognised the need for rationalising the
procedures for expenditure sanctions and has delegated enhanced powers to the
administrative ministries in their various delegation schemes. The purpose is to
improve the procedures for prebudget scrutiny and to delegate powers of post-budget
expenditure sanctions to the administrative departments, within broad limits. There
have been various issues in Executive Control over expenditure, control by Finance
Ministry and the delegation of firiancial powers in the Government'of India
b inanrial Control
KEY WORDS
Structure
Objectives
Introduction
Accounting : Definition and Importance
Principles and Methods of Government Accounting
Separation of Accounts from Audit
Departmentalisation of Accounts
Revised Accounting Structure
Management Accounting in Government
Let Us Sum Up
Key Words
References
Answers to Check Your Progress Exercises
21 .O OBJECTIVES
After studying this unit, you should be able to :
explain the differences between Commercial and Government Accounting
discuss the advantages and disadvantages of the separation of accounts from Audit
and its present position in Government
explain the main features of Departmentalisation of Accounts
describe the essentials of the Revised Accounting Structure; and
analyse the concept of Management Accounting and its limitations in Government.
21.1 INTRODUCTION
Accounting, whether in a commercial organisation or in Government, is a tool of
management, In a manufacturing organisation, it provides information to
management about the cost of manufacturing a product, the cost of performing a
job, the cost of sales and the profit earned or loss incurred etc. Similarly, in a
commercial organisation, it provides information about the profit or loss and also
the increase or decrease in the assets and liabilities of the organisation. It also
provides data for proper budgetary control. In the case of government, accounting
helps the various levels of management, in the preparation of plans and exercise of
, proper financial control. By providing data about the expenditure incurred on
various activities, it helps budget planners to determine in advance, the taxes to be \
I
levied and also the areas, where the cut in expenditure is possible. Again, it helps the
management in proper monitoring and implementation of plans, schemes. Thus,
I
accounting is an useful'aid to management in performing its various managerial
I
functions effectively.
i In this unit, the difference between commercial accounting and government
i accounting has been explained. The recent reforms in government accounting viz.,
I Departmentalisation of Accounts, Revised Accounting Structure, Management
i
Accounting have also been explained.
I ..
! .
ACCOUNTING : DEFINITION AND
i 21.2
IMPORTANCE
.The word accounts in the financial sense, has been defined as statements of facts
relating to money or things having money value. The facts that are incorporated in
- - _ - -> - --- >----:L-?J -- L-----A :^-^
Aeeountn md ~ u d i t In the early stages of civilisation, the number of transactions to be recorded was so
small that each businessman was able to record and check for himself/ herself all the
transactions. But with the growth of trade, it became difficult for him/ her to know
from the records, how she/ he stood in relation to his/ her customers and whether
her/ his business was profitable or not. This gave rise to the maintenance of accounts
on a doubleentry basis, which was helpful in the preparation of profit and loss
account and balance sheet of the business. The process through which these ends are
effected is called "accounting."
Accounting is a discipline which records, classifies and summarises data and presents
it in a convenient form to various levels of management in an organisation for
decision-making purposes. It helps managers to prepare their budget plans
realistically so that the expenditure could be watched against the budget allocation,
and corrective action could be taken, wherever necessary. It also helps outsiders i.e.
shareholders/ government, to know the working of the business firm, by presenting
data about its activities, profit or loss and its assets and liabilities.
In government, accounting provides information for the preparation of annual
budgets. It helps budget planners to determine, in advance, the taxes to be levied for
meeting the committed expenditure, or to reduce the expenditure, wherever possible.
-
It provides information to managers about the expenditure involved annually, on
pay, allowances, materials etc. and also the expenditure incurred on Plan Schemes. It
also provides information regarding expenditure incurred on functions, programmes,
activities, for the speedy development of performance budgeting in all departments of
government. It further helps in exercising proper financial control and observance of
rules and regulations by the various authorities. Its main purpose is to provide timely
information to various levels of management, for taking proper decisions in respect
of their areas of operations and for monitoring the performance of activities against
their physical targets and also the expenditure against the budget, so as to enable the
government to take corrective action, wherever considered necessary.
A commercial concern deals primarily with the utilisation of capital for the purpose
of making a profit. It is interested in seeing at intervals, how it stands in relation to
its debtors and creditors, whether it is gaining or losing, what are the sources of its
gain or loss. In order to obtain ready answers to these questions, the concern has to
keep a system of detailed accounts. In respect of each person dealt with, and each
department of its activities, it maintains a separate accourit, so that the result of the
transactions in each case may be ascertained. By preparing the manufacturing,
trading and profit and loss accounts and balance sheet, the concern is able to know
the profit earned or loss incurred during the year.
It is a generally accepted practice in the commercial world to m9intain account
books on the double entry system. The double entry system is based on the fact that
in every transaction, two parties or accounts are involved-one giving and the other
receiving. Under that system, every transaction requires two entries in the books, one
against the party or account giving and the other against the party or account which
is receiving.
The activities of a government, on the other hand, are determined by the needs of
the country. If the activities to be carried out, during the coming years, are known, it
becomes easier to determine the funds required to carry out those activities.
Government accounts are, therefore, designed to enable the government to
determine, how much money it needs to collect from the tax-payers in order to Accounting System in lndr
maintain its activities.
i) Introduction
Accounting and auditing are interrelated but have independent functions. For reasons
mainly of economy, these have been traditionally combined under one authority.
From time to'time, however, attempts have been made to separate accounting from
auditing as in the case of railways, defence, food, rehabilitation and supply. In 1971,
the Comptroller and Auditor General's (Duties, Powers and Conditions of Service)
Act was passed, which visualised the need for separating accounts from audit.
Section 10 of the Act empowered the President, after consultatiorl with the CAG. to
relieve the Comptroller and Auditor General from the responsibility of compiling the
accounts of any department of the Union Government. A scheme for the separation
of accounts from audit was approved by the Government of India in June 1975. An
ordinance was issued by the President, which was followed by passing an Act, which
amended the Comptroller and Auditor General's (DPC) Act 1971, thereby relieving
him from the responsibility of compiling accounts of Ministries1 Departments of
Government of India. He, however, still performs the accounts and audit functions
in each state.
Accounts and Audlt c) Federal structure has been prescribed by the Constitution with autonomy to the
states. With the state accounts handled by a functionary directly under the
President, entrusting accounting duties to the' Comptroller and Auditor General
would lead to the loss of the accounting autonomy of the states.
d) The combined accounts and audit dffices function with less speed in the
performance of their accounting duties, i.e. in the timely payments of dues,
such as salary, pension, provident fund, gratuity etc.
The disadvantages listed out above are not so great as to justify opposition to the
separation for all times to come. The mere fact that separate accounts organisations -
of Defence, Railways, Lok Sabhal Rajya Sabha Secretariat and the separated
Ministeries of Works, Housing and Supply etc. are functioning with efficiency, it dispel
- the fears enumerated. In fact, the disadvantages arising out of combined accounts
and audit organisations are more than the advantages accruing out of it.
v) Separation of Accounts
Realising the increasing need for separation of accounts from audit, the Government
of India decided to departmentalise the accounts of the Central1 Ministries1
Departments, which had been with the Comptroller and Auditor General of India.
All Ministries of the Government of India including the Posts and Telegraphs
Department were brought under the Scheme of departmentalisation of accounts
between 1st &I to 31st December, 1976.
>
subordinate officers. Apart from the Headquarters set up, evely Ministry
P . .. . - . - -. -- - -.
ii) The Comptroller and Auditor General was relieved of the responsibility of Accounting system in India '
compiling and keeping the accounts of transactions relating to the Departments
of the Ministries. Payment functions discharged by the treasuries were also
taken over by the Departments. According to the practice, prior to
departmentalisation of cc unts, the main Ministry and the subordinate offices
3 I?
used to draw funds by means of presenting bills in treasuries. The treasuries
used to render accounts to the respective Accountant Generals, who compiled
the monthly accounts. Each Accountant General rendered a monthly account
of Central Gover ment transactions to the Accountant General, Central
?
Revenues in Delhi! for consolidation and preparation of civil accounts.
iii) The Secretary of each Ministry is designated as the Chief Accounting Authority
responsible for all transactions of the Ministry and its Departments. This
responsibility is discharged through the Integrated Financial Advisor (IFA) of
the Ministry. The Secretary has the over-all responsibility for the functioning of
the accounting and payment set-up and is responsible for certification of
monthly accounts.
I iv) The Integrated Financial Advisor performs the following duties, on behalf of
the Chief Accounting Authority. He/She will be responsible for:
a) The preparation of the budget of the Ministry and its Departments in
coordination with the Heads of Departments concerned and distribution
of the budget allotment among the various wings/ departments of the
Ministry. Control of expenditure will also form a part of his/ her
responsibility.
b) Arranging payments to autonomous bodies, corporations, authorities, and
also grants-in-aid, loans etc.
'c) Arrangements for making payments through the Pay and Accounts offices
of pay and allowances, office contingencies and miscellaneous payments.
d) Consolidation of the accounts of the Ministry as a whole, in accordance
with the instructions issued by the Central Government.
e) Preparation of Appropriation Accounts for the grants controlled by the
Ministry.
f) Organising a sound system of internal check to ensure accuracy in
accounting and efficiency of operation as part of management.
g) Introduction of an efficient system of Management accounting best suited
to the functional requirements of the Ministry and its Departments.
v) The payments relating to the Ministries/Departments which are now made by
the Bank and non-Bank treasuries, Accountant General and State Pay and
&counts Officers, will be made by the Departmental Pay and Accounts
Offices.
'\
In brief, departmentalisation of accounts was done mainly with a view to enable the
Ministries to exercise direct control over their expenditure and to introduce a
management accounting system, so as to provide relevant information to various
levels of.management for taking proper decisions.
\
..............................................................................................................................
2) Explain the disadvantages of the separ-&n of accounts from audit.
..............................................................................................................................
3) Explain the salient features of departmentalisation of accounts.
The accounting system introduced by the British in the early years of this century
remained more or less unchanged till April 1974.
The classification in the accounting system introduced by the British, was mainly to
facilitate financial and legal accountability of the Executive t o the Legislature and
within the Executive. of the spending agencies t o the sanctioning authorities. Again.
the classification had close relationship to the department in which the expenditure
occurred than to the p d o s e s for which thermoney was spent. The basic concern
was the item on which money was spent rather than the purposes served by it. This
system served well so long as the functions of the Government were limited. But with
a change in the role of Government, i.e. undertaking developmental programmes for
the socio-economic development of the country under the successive Five Year Plans,
need was felt for bringing in necessary reforms in the system of accounts, so as t o
meet the challenges of development administration.
In part I1 of the Demands, details of expenditure upto the level of major and minor
heads of account may be included.
In part 11i of the Demands, further details may be given about the provisions made
in part 11 for minor heads and for activities/schemes/organisationsunder minor
, ,
heads.
-.A
The team submitted the second report in November 1972. It proposed a five tier
classification structure.
The team mentioned that the new classification would facilitate a link between
budget outlays and functions, programmes-and activities. It would also ensure
itemised control of expenditure. Also, the classification would facilitate introduction
of performance budgeting.
Social and Community services sector covers programmes and activities relating to
provision of basic social services to consumers, such as Education, Medical Relief,
Housing, Social security and Welfare and Services required for community living
such as Public Health. Urban Development, Broadcasting etc. Economic Services
Sector includes programmes and acthities in the fields of Production. Distribution,
Trade, Regulation ctc.
,-
In the new scheme of accounts, a Major Head is assigned to each function, and a
Minor Head is allottcd to each Programme. Under each Minor Head, there would
be sub-heads assigned to activities/schemes/ organisations covered by the
progra*me. Major and Minor Heads classification is common to Union, States and
Union territories Govclmments. Under the new scheme, the object classification has
been retained and placed as the last tier. I t is meant to provide item-wise control
over expenditure and to ensure financial control.
It may be concluded that the. recent financial reforms introduced in the Government
of India, namely, revised accounting structure, departmentalisation of accounts,
performance budgeting, Integrated Financial Advisor Scheme etc. are all intended to
facilitate the early introduction of management accounting in government. The
reforms already started should be carried forward, so that the management
accounting system developed in a Ministry/ Department, could provide timely
information to various levels at management for speedy decision-making,
--
' Check Your Progress 2
Note : i) Use the space given below for your answers.
ii) Check your answers with those given at the end of the unit.
1) Why was the accounting system introduced by the British revised?
Accounting Syrtem In Indh
21.10 REFERENCES -
Chandrasekharan R.K., 1990. The Comptroller and Auditor General of India
(Vol. I ) , Ashish Publishing House : New Delhi.
RamachandrantK.S., 191 1. Wutc-17ingover a Watch Dog, Ashish Publishing House:
New Delhi.
Structure
Objectives
Introduction
Auditing: Definition and Importance
Evolution of Auditing in India
Statutory and Internal Audit
Types of Audit
Independence of Audit
Results of Audit-Audit Reports and their Follow-up with Administration
Let Us S u m Up
Key Words
References
Answers t o Check Your Progress Exercises
22.0 OBJECTIVES
After studying this unit, you should be able to: ..
explain the meaning and importance of audit
describe the differences between Internal and Statutory audit
analyse the features of Regularity audit and Performance audit
understand the utility of audit reports and their impact on administration.
22.1 INTRODUCTION
Audit deals with papers and figures. I t is in the nature of a post-mortem
examination of accounting and financial transactions of a firm or a company or a
department of Government.
An auditor has a vital role to play in modern economy. With the growth of joint-
stock companies with limited liability, there is divorce between owners (share-
holders) and managers (Board of Directors). This has made it important that there
should be an independent auditor to check the correctness of the financial
transactions of a limited liability company on behalf of the shareholders, as a means
of managerial accountability to thc owners. Likewise, on the basis of audited
accounls, certified by a n auditor. the tax authorities can be reasonably certain that
the profit or loss, disclosed by a n assessee, is reasonably true and correct, instead of
* undertaking a check of accounts of the assessees.
Audit is a valuable aid t o administration. 1nBH countries, audit is not just tolerated
as a necessary evil but is looked upon a s a valued ally, which brings t o notice
procedural and technical irregularities and lapses on the part of individuals, whether
they may be errors of judgment, negligence or acts and intents of dishonesty. The -1
complementary roles of audit and administration are now accepted a s a fact, being
essential for toning up the machinery of government-In the ultimate ana!ysis, audit'
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2 2 3 EVOLUTION OF AUDITING IN INDIA
I
1
i
The evolution of auditing in India, as well as in other countries, has been a gradual
process. It has been closely related to the activities undertaken by the government,
the internal control and management systems available in government departments.
; In the pre-war era, the main functions of government were collection of revenue,
maintenance of law and order, defence and execution of public works of certain
kinds. Few governments undertook commercial activities. In such a situation, the
functioh of audit was largely one of regularity and compliance audit. The principal
components of audit in the re-war era were (a) audit against budget provisions
(b) audit against sanctions (c) audit of accounts and appropriations (d) expenditure
aud'it and (e) propriety audit. Audit against budget provisions and against sanctions
I constituted what was known as complhnce.or regularity audit [See Section 22.5 (i)].
The highest form of audit within the traditional framework. was considered to be
propriety audit. A transaction. which was otherwise in order and in conformity with
I
rules and regulations, could still be objected to on the ground that it breached broad\
concepts of financial ethics.
In the post-war era, the welfare state had to undertake several socioeconomic,
commercial and industrial programmes to speed up development and improve the
quality of life of the people. Correspondingly. audit had to shift its emphasis so that
it was io a position to report to Parliament. whether or not these
programmesiactivities had achieved their objectives. New areas of audit had to be
covered and new techniques had to be developed. With increasing activity.
government departments and agencies had to build up their own systems of internal
control.
The transition from the traditional type of audit to the audit of economy, efficiency
and effectiveness of activities (the three E's audit) was achieled. through an
intermediate stage of value for money audit. which covered the economy and
efficiency aspects. Broadly. it can be said that economy audit is aimed at ensuring
that the activities are undertaken and completed at the lowest possible cost.
Efficiency audit is concerned with ascertaining that an activity is completed
according to a pre-determined output to input ratio and according to a pre-
determined time table. In the audit of effectiveness of programmes, it is necessary to
determine whether the objectives for which the-programmes were undertaken, have
been achieved and whether the programmes had the intended effect on the social and
economic life of the people. Thus, broadly, it can be stated, that in the earlier stage.
. traditional audit was concerned with economy. at the intermediate stage. it Was
concesned with economy and efficiency and that today it is concerned with economy,
efficiency and effectiveness.
As already mentioned. the evolution of government auditing in India has been a
gradual process. coinciding with the changes in the functions of government. Until
1950. government audit was mairJy expenditure oriented. Appropriarion audit;
regularity audit, sanction audit, propriety audit etc. were conducted by the Indian
Audit and Accounts Department, in so far as they related to individual transactions
of government. The techniques and procedures prescribed for conducting audit, by
and large. fulfilled the task of transaction audit of government expenditure.
The concept and practice of audit of expenditure has undergone radical changes in
the post-independent era (after 1950). Following the development of parliamentary
democracy and introduction of successive Five Year Plans for national
development-social, economic and industrial-massive investments have been made
by the government at the centre and in the states. .When the pattern of government
( ex&dituredimension underwent a radical and rapid transformation in the wake of
successive national plans, it was felt that the scrutiny of individual transactions was.
inadequate, as it tended to mistake the tree for the woods. It became. therefore,
essential for audit to ascertain whether the various developmeilt programmes and
welfare activities were being properly executed and their operations conducted
economically, whether they were producing the results expected of them. Hence she
concept of efficiency audit was introduced to meet the changing requirements in the
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:
Accounts iunl Audit Introduction of performance budgeting and functional classification in government
accounting gave a new dimension to efficiency-cum-performance audit. Since 1962,
when the technique of efficiency-cum-performance audit was develcped, it has been
applied to the transactions connected with the development programmes. The
introduction of comprehensive appraisal of the public sector undertakings and
evolution of the mechanism of Audit Boards with built-in external expertise, saw yet
another extension of the technique of efficiency-~um~performance audit. In addition,
audit also covered new areas i.e. audit of tax receipts, audit of scientific departments
etc.
With the shift in approaches in audit, changes have been introduced in the content
and presentation of audit reports. Thus, the evolution of auditing in India has been a
gradual process, matching with the changes in the functions of government.
Statutory Audit
Statutory audit refers to the audit conducted by the Comptroller and Auditor
General, through the agency of the Indian Audit'and Accounts Department. As per
the Constitution as well as by the CAG CDPC) Act, 1971, it is the function of the
Comptroller and Auditor General to (i) audit all expenditure from the Consolidated
Fund of India of the Union, of each State and of each Union Territory, having a
Legislative Assembly and to ascertain whether the money shown in the accounts a s
having been disbursed were legally available and applicable to the service or purpose
to which they have been applied of charged and whether the expenditure conforms
to the authority who governs it and (ii) to audit all transactions of the Union and of
the states relating to the contingency functs and public accounts. The Comptroller
and Auditor General has been given, under the Constitution, access to the accounts
of expenditure incurred against appropriations granted by Parliament. The CAG is
empowered to inspect any office connected with the t r a n s a c t i v to which his/ her
authority extends.
Internal Audit
lnternaiaudit, on the other hand, is internal to the organisation. Internal audit is
conducted by an agency or departmeyt created by the management of the
organisation. It is an integral part of the organisation and functions directly under
the Chief Executive. It is in the nature of an internal service to the Executive for
smooth and efficient functioning and for reviewing and improving its performance.
The common objectives of an internal audit. inter-alia are to ( i ) check the adequacy,
soundness and applicability of the systems of internal controls (Accounting, financial
and other operating controls); (ii) prevent and detect frauds (iii) check on the
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performance-cum-efficiency audit of an operation1 programme1 activity of an entity as AudltIIIg SW&I IIIl n d ~
a whole, or its parts designed to different levels for any of the objective, set by the
management.
Internal audit, in any organisation, does not possess the same kind of independence
as is available to the external audit, conducted by the Indian Audit and Accounts
Department. There is, however, no conflict between internal and external or
statutory audit. Where internal audit is adequate, the extent of statutory audit is
limited to test checking of internal audit work.
The broad aim of audit is to safeguard the financial interests of the tax payer and to
assist the Parliament1 Statel Union territory legislatures in exercising financial control
I
over the executive. It is the function of the Comptroller and Auditor General to
ensure that the various authorities set up by or under the Constitution, act in regard
to all financial matters, in accordance with the Constitution and the laws of
Parliament and appropriate legislatures and rules and orders issued thereunder. In
order to discharge the auditorial duties entrusted by the Constitution to him/ her, the
Comptroller and Auditor General (CAG) conducts various types of audit viz.,
Financial audit, Regularity audit, Receipts audit, Commercial audit, Audit of stores
and stock, Petformance audit etc. In the performance of this stupenqous task, the
CAG is assisted by the accounting authorities in various ministries and by the
Principal Accounts Officers functioning in various states. Some of the features of
Financial audit, Regularity audit, Receipts aadit, Performance audit are explained in
Financial Audit
Financial audit is the audit conducted by the Indian Audit and Accounts
Department to see whether the administrative action of the executive is not only in
conformity with prescribed law, financial rules and procedures, but it is also proper
and does not result in any extravagance. Finaircia1 audit does not concern itself with
the audit of administrative organisations and procedures and is different from
administrative audit. It is the duty or the function of the executive government to
frame rules. regulations and orders. which are to be observed bv its subordinate
Accounts and Audit in waste. extravagance o r !mproper expenditure. it is certainly the duty o l audit to
call specific attention to matters of that kind and to bring the lacts to the notice of
Parliament. For instance, in a canal project construction. audit would not concern
itself with the administrative set-up for the actual construction of the canal and
whether it should pass through a particular part of the country or not. These are
matters of administration a n d no scrutiny of these processes will be done by the
audit. But if it is found that the alignments had been drawn up on insufficient data.
necessitating a subsequent change involving additional expenditure o r that the
financial results were less than what had been anticipated, then it is the duty of audit
to examine the circumstances which resulted in the wrong alignments resulting in
loss o r avoidable expenditure to the tax payer. Audit interferes only when
administrative action has serious financial implications and is not in comformity with
prescribed law, financial rules and procedures. Financial audit also includes audit
against propriety o r broad principles of orthodox finance. Thus, financial audit
safeguards the interests of tax-payer by bringing to the notice of Parliament, wastage
in government expenditure.
Regularity Audit
Regularity audit consists mainly In checking that the payments have been duly
authorised and are supported by proper vouchers in the prescribed form. Its main
purpose has been t o ensure conformity with the relevant administrative, financial
budgetary and accounting rules and regulations provided for in the Constitution or
the laws made by Parliament.
iii) that the claims are made in accordance with the rules and in proper form;
iv) that all prescribed preliminaries t o expenditure a r e observed, such a s proper
estimateq framed and approved by competent authority for works
e x p e n d i t h e , a health certificate obtained, where necessary, before S t
' .e
disbursement of pay to a government servant;
V) that the expenditure sanctioned for a limited period is not admitted in audit
beyond that period without further sanction;
vi) that the rules regulating the method of payment have been duly observed by
the disbursing officer;
vii) that payment has been made to the person and. that it has been acknowledged
a n d recorded 50 t second claim against government o n the same account,
is not possible; a n
viii) that the payments have been correctly brought into account in the original
documents.
Audit against provision of funds, aims at determining that the expenditure incurred
'
has been o n the purpose for which the grant and appropriation had been provided
a n d that the amount of such expenditure does not exceed the appropriation made.
Audit, in relation t o audit'of expenditure, is t o ensure that each item of expenditure
is covered by a sanction of the competent authority. Audit against rules a n d orders is
a n important aspect of regularity audit. It ensures that the expenditure conforms t o
the relevant provisions of the Constitution and of the laws and rules made
thereunder. Audit of expenditure against regularity is a quasi-judicial type of work,
performed by the audit authorities. It involves interpretation of the Constitution, ,
rules and orders.
Receipts Audit
Receipts audit involves the audit of income-tax and custom and excise receipts at
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level. From the late fifties, receipts audit has been conducted by the Indian Audit Auditing System in I?din
and Accounts Department,
Performance Audit
Financial audit and Regularity audit generally involve scrutiny of individual
transactions. They do not focus on the evaluation of a scheme or a programme to
which these transactions relate. Therefore, both types of audits have been found
inadequate for an evaluation of the performance of an organisation in terms of its
goals or objectives.
Ever since the Government launched Five-Year Plans, investment on a large scale
has been made on developmental activities for acceleration of socio-economic
development of the country. In many cases, the investments did not give the
expected returns. Therefore, public has a right to know whether the results achieved
had been commensurate with the resources invested. The public concern has found
expression in the introduction of performance budgeting in government.
The change in the thinking of government, In recent tunes, about the need to relate
expenditure to corresponding physical accomplishments made it also t o think about
the functions of audit. It has been accepted that Regularity audit/Propriety audit is
essential for parliamentary control of expenditure. However, in view of the
increasing developmental expenditure, under the successive Five Year Plans, a%dit
should examine the achievements of specific programmes, activities and projects in
terms of their goals or objectives. It has been felt that audit should bring out those
cases where utilisation of resources has been sub-optimal. This has resulted in a
serious thought being given to the need for performance audit which is also called
efficiency unit.
Performance audit seeks to find out whether the resources have been utilised
efficiently by deploying them in an optimum manner. It highlights the extent to
which resources are put to productive uses. It also highlights as to what extent
quantified benefits could be expected from such deployment of resources.
Although the technique of performance audit is sound and useful, there are many
problems in conducting such an audit. Firstly, performance evaluation of an activity
can be made only in the light of the objectives, which is expected to achieve.
Objectives spell out the results desired from an activity. Whereas inputs are easy to
measure for an activity, tremendous effort is required to quantify and measure the
resulting output, particularly when this output has a social context.
Lastly, effectiveness of performance audit would depend onthow best the yardsticks
of performance have been evolved. The technique of performance audit can be
applied successfully in cases, where normslstandards are available for application. It
is easier to apply in manufacturing organisations, than in the case of governmental
organisat ions.
In India, the concept of performance audit is of recent origin. Its scope is unlimited.
T o conduct performance audit of public undertakings, Audit Boards have been set
up. These Boards have been functioning, under the Comptroller and Auditor
General, since April, 1969.
Secondly, the Constitution provides that the Parliament shall have exclusive power to
make laws on the subject of audit of the accounts of the Union and of the States. At
the same time, the Constitution has not made the Comptroller and Auditor General
of India a n officer of Parliament or of the House of the People. In practice also, the
States do not regard him as a n officer of the Union but a functionary created by the
Constitution for purposes of both the States and the Union Government.
Thus, the Comptroller and Auditor General of India occupies a unique place. He
certifies the share of the States of the taxes collected by the Union and the
amoults so certified are accepted by the State Governments without demur. He
certifies the expenditure incurred by the States on public expenditure programmes
initiated and financed by the Union and the Union Government accepts the figures
without question. The Comptroller and Auditor General of India, thus plays a
fiduciary role in the sensitive Union-State relations.
Thirdly, the Constitution guarantees the independence of the Comptroller and
Auditor General of India by prescribing that he shall be appointed by the President
of India by warrant, under his hand and seal, and cannot be removed from office
except on the ground of proved misbehaviour or incapacity.
Fourthly, while Parliament will be competent to make laws to determine his salary
and other conditions of service, they cannot be varied to his disadvantage, after his
appointment.
Fifthly, on retirement, resignation or removal, the Comptroller and Auditor General
is prohibited from holding any further office either under the Government of India
or under the Government of any State. %
Sixthly, the salary and allowances of the Comptroller and Auditor General, the
pension etc., payable to retired Auditors General and the administrative expenses of
Comptroller and Auditor General's personal office, shall be charged on the
-
Consolidated
.. Fund of India. That is, they will not be subjected to the vote of
Lastly, the Constitution furtliir provides that thd conditions of service of persons Auditing System in Jndin
serving in the Indian-Audit and Accounts General shall be determined by the
President after consultation with him. The Constitution, thus, provides adequate
safeguards to the Comptroller and Auditor General to enable him/ her perform
his'/ her constitutional functions, without any fear from the Executive. (These issues
are dealj-with in detail in assessing the role of Comptroller and Auditor General in
Unit 23.)
An independent judiciary and an independent audit are two of the more important
elements of democracy. On them, devolves in varying degrees, the responsibility of
protecting democracy from authoritarian trends and executive excesses. Our
Constitution has taken, therefore, reasonable care to safeguard their independence.
The results of audit are required to be reported by the Audit Officer to the
administrative authorities concerned at the earliest opportunity. These authorities
then become responsible for the settlement of objections raised by audit authorities.
It is also the responsibility of the administrative authorities to effect recovery of any
amount disbursed wrongly. The Audit officers keep pursuing the objections raised by
them till these are settled to their satisfaction by the administration. Finally, after
completion of a year's accounts, the results of audit are reported to the concerned
Government and their legislatures through the instrument of Audit Reports.
Though Audit Reports appear post mortem, they serve many purposes:
They are a n aid to administration/management to ensure that irregularities are
not repeated in future.
They help the planning process in not conceiving faulty schemes.
They give the right signals for mid-course corrections in on-going schemes.
They also serve the basis for taking appropriate disciplinary action by the
administrative authorities concerned against the persons who have caused loss to
, the exchequer by their acts of omission and commission to act as a deterrent.
Audit Reports should, however, be largely current and should be able to bring out
the failures, drawbacks or the deficiencies as quickly as possible, so that prompt
. remedial measures can be taken by the administration.
I
The Constitution has prescribed the procedure to be followed by the Comptroller
and Auditor General for presentation pf the audit reports. The reports of the CAG
in regard to the Union Government accounts shall be submitted t o the president and
the State Government accounts, shall be submitted to Governor of the State. At
present, the Comptroller and Auditor General submits three reports viz., i) Audit
Report on the Appropriation Accounts, ii) Audit Report on the Finance Accounts
and iii) Audit Report on the commercial and public sector enterprises and revenue
receipts on Union and state governments.
The responsibility of the Comptroller and Auditor General ceases with the
submission of the audit reports to the President/Governor who causes them to be
laid before the ParliamentlState legislatures respectively. In actual practice, the audit
renorts of various novernments are received hv the Ministrv nf Finance on hehalf of
- - - -
the President. The Finance Minister lays them on the table of each House of
Parliament. Regarding Audit Reports of states, similar procedure is followed
generally.
2) Explain the meaning and scope of Performance Audit in India. Auditing System ~ Indla
..............................................................................................................................
..............................................................................................................................
.' /, ,
.................................................................................................................. . .......
%.:.A"
The evolution of auditing in India has been a gradual process, coinciding with the
growth in the functions of Government. Initially, auditing was primarily expenditure
oriented. Gradually, audit of receipts was taken up. With the growth of public
enterprises, commercial audit came into being. Recently, audit has gone into the
evaluation of the performance of organisations, activities, projects etc.
The Comptroller and Auditor General of India is responsible for conducting audit of
the accounts of the Union, states and union territories with legislature. He/ She
conducts regularity audit, receipts audit, commercial audit, performance audit etc.
The Constitution has provided adequate safeguards to protect the independence of
the Comptroller and Auditor General from the Executive. He/ She will be appointed
by the President but can be removed only by the Parliament. His/ Her tenure,
conditions of service cannot be varied to his/ her disadvantage, after his/ her
appointment. He/ She cannot accept employment after retirement or dismissal, either
under the Union Government or under the state government. His/ Her salary,
allowances and pension as well as his/ her establishment will be charged upon the
Consolidated Fund of India and not voted.
Audit Report is the final destination of audit. The Comptroller and Auditor General
submits three reports i.e. Audit report on appropriation accounts, auditreport on
finance accounts, and audit report on the commercial and public sector enterprises
and revenue receipts on Union and State Governments, to the President/Governor of
ry with legisla\turs, who causes them to be
e legislatures resp'ectively. The Audit reports
ommittee. Besides providing the material, the
s the committee, by preparing memos-on
. /'
Accounts and Au& are accepted By the Government. In case some recommendations are not acceptable
to Government, the Committee examines the same and submits Adion-taken Report
to the Parliament.
To sum up, audit is not an inquisition and its mission is not one of fault-finding. Its
purpose is to bring to the notice of the administration lacunae in the rules and
regulations, irregularities and lapses and to suggest wherever possible, ways and
means for the execution of plans and projects with greater expedition, efficiency and
economy.
22.10 REFERENCES
Chanda, Asok, 1958. Indian Administration. George Allen Unwin Ltd.: London.
Chanda, Asok, 1960. Aspects of Audir Control, Asia Publishing House: om bay.
Handa, K.L., 1979. Programme and Performance Budgeting, Uppal Publishing
House: New Delhi.
Krishan Y., 1990. Audit in India's Democracy, Clarion Books: New Delhi.
Mookerjee Sameer C., 1989. Role of Comptroller and Auditor General in Indian
Democracy, Ashish Publishing House: New Delhi.
Ramayyar M.S., 1967. Indian Audir and Accounts Department, The Indian Institute
of Public Administration: New Delhi.
23.0 OBJECTIVES
After studying this unit, you should be able to:
understand the origin and constitutional position of CAG;
describe the duties of CAG in respect of Accounts and Audit; and
analyse the role of CAG in Indian Democracy.
23.1 INTRODUCTION
Exercise of financial control is one of the principal responsibilities of the legislature.
Parliamentary financial control on government spending is implemented in two
stages: primarily at the time of policy making and subsequently by controlling the
implementation of the policy. Budget or the Annual Financial Statement showing the
estimated receipts and expenditure of the Government for the ensuing financial year
is presented and discussed in the Parliament or Legislature. The initial parliamentary
financial control is exercised through the AnnuaI Budget Estimates of the
Government for the ensuing financial year, which is presented to the House for
approval.
Similarly, Gupta rulers introduced more elaborate and orderly system of accounts
and audit during their rule. According to Ramachandra Dikshitar "The accounts
were maintained, as during the days of their predecessors, the Mauryas, and were
submitted periodically for audit and approval. This is made clear to us by th'e term
PATYUPARIKA. This may be translated broadly as corresponding to the modern
Accountant General. The Accountant General who presided over the accounts
department was responsible to the Council of Minister for his acts. I t is evident that
there was an elaborate Department of Accounts in the Gupta time." Likewise, the
medieval rulers, viz. Sultans and Moghuls, laid proper stress on collection of revenue
and conduct of audit. The Moghuls vested greater authority in their financial chief.
by naming him as the Vnrir or Dewan.
In 1858. when the East lndia Company's administration was taken o\vr by the
Crown, a comptementary post ol Accountant-General at the India office was created
\
to prepare the accounts of the expenditure incurred in England. Simultaneously, an
independent Auditor was appointed by the Crown for the audit of these accounts.
This arrangement was, however, shortlived. In 1860, both accounting and auditing
f u n a o n s were amalga.mated and placed in charge of the Accountant-General to the
Government of India. who was designated as 'Auditor General'.
The statutory recognition of the Auditor General came, however, only in 1919, with
the introduction of Constitutional Reforms. He was made independent of the
Government af lndia and was appointed by the Secretary of State and held office as
the administrative head of the Indian Audit Department. during his Majesty's
pleasure. The Government of lndia Act 1935 gave further recognition to the
importance and status of this office. Thereafter, his appointment was made by His
Britannic Majesty and the conditions of his service were also determined by His
Majesty-in-Council. His duties and powers were prescribed by rules made under the
order of His Majesty-in-Council. His salary, allowances. and pension were made
chargeable on the revenues of the Federation. He could be removed from office only
in the same manner and on the same grounds, as a Judge of the Federal Court.
With the incorporation of the Government of lndia Act 1935 in the Independence -
Act 1947, the authority of the Auditor-General was further enhanced and the auditor
of the Indian accounts in United Kingdom was placed under his administrative
control. With the subsequent integration of the princely states in the federal structure
of the Indian Union, his audit responsibility was extended to the whole of India.
The Constitution Act, 1950, redesignated the Auditor General as Comptroller and
rr r.. ..... C.. -
Auditor General and made him, alongwith the Judges of the Supreme Court, an
.._.. 1 . . ...... " . . . P
- -
financial administration of India, whether in the States o r the Union, should come
under the coordinating authority of a single officer of Constitution, the Comptroller
and Auditor General.
For the purpose of securing the highest standards of financial integrity of the
administration and watching the interest of the tax-payer and also for purposes of
Legislative control, the Constitution safeguards the independence and freedom of the
Comptroller and Auditor General in the following ways. / , \
1) Article 148 of the Constitution lays down that the Comptroller and Auditor
General of lndia would be appointed by the President by warrant under his
hand and seal. The CAG will hold office for a period of six years o r till he
attains the age of 65, whichever is earlier. And he can be removed from office
only in the same manner and on the same grounds as a Judge of the Supreme
Court i.e. by impeachment in Parliament.
2) T o further ensure that the Comptroller and Auditor General cannot be
influenced by the Executive, the Constitution provides, as per Article 148(3) that
the salary and other conditions of service of the Comptroller and Auditor
General are such as determined by law and cannot be varied to his
disadvantages, after his appointment.
3) The Comptroller and Auditor General is debarred by Article 148(4) from
holding any office either under the Government of India o r the State
Governments, after he retires from the office of the Comptroller and Auditor
General.
4) Furthermore, as per Article 148(6) all salaries, allowances and pensions payable
to o r in respect of persons servihg in t p t office, shall be charged upon the
Consolidated Fund of India.
5) The Comptroller and Auditor General is the Administrative Head of the Indian
Audit and Accounts Department. His administrative power will be governed by
rules made by the ?resident, in consultation with the former.
i .
Executive, whose tda sactions he is expected t o audit.
He also provides the necessary information to the Union and States in the
preparation of their Budgets (i.e. knnual Financial Statement).
The functions of the Comptroller and Auditor General, in brief, in so far as accounts
are concerned, are mainly:
1) the prescription of forms in which accounts are to be kept in the Union and of
the States;
2) preparation and submission of Finance Accounts and Appropriation Accounts
to the President/Governor/Administrator of Union Territory as the case may be,
and
33 providing information to UnionlState Governments for preparation of their
annual budgets.
As per the CAG (DPC's) Act, 1971 the auditorial functions of the Comptroller and
Auditor General are as follows :
a) to audit all receipts into and expenditure from the Consolidated Fund of India
and of each State and of each Union territory, having a Legislative Assembly
and to ascertain whether the money shown in the accounts as having been
disbursed were legally available for and applicable to the service or purpose for
which they have been applied.
b) to audit all transactions of the Union and of the States relating to Contingency
Funds, and Public Accounts.
c) to audit all trading, manufacturing, profit and loss accounts and balance sheets
and other subsidiary accounts kept in any department of the Union or of a
State; and in each case to report on the expenditure, transactions or accou?ts so
audited by him.
d) to audit receipts and expenditure of bodies or authorities substantially financed
from Union or State revenues.
e) to audit the accounts of Government, Companies and Corporaions established
by or under the Law of Parliament, or in accordance with the provisions of
respective Legislations.
f) to audit account of bodies or authorities by request.
In connection with the discharge of the auditorial duties,, the Comptroller and
Auditor General can inspect any office of accounts under the control of the Union or
a State, including treasuries and offices responsible for keeping initial or subsidiary
accounts. In short, the Comptroller and Auditor General is responsible for the audit
of the accounts of the Union and of the States and of bodies substantially financed '
f r n m ITninn n r C t a t e reveniiec Flirther h e l c h ~aiiditc t h e arrniintc n f r n m n a n i p c nnrl
corporations and of autonomous autpor/ities, whose audit has been entrusted by law
to him/her public interest. In the per/fo#mance of the duties, he/she is assisted by the
1
Indian Audit and Accounts Dep rtment. .
1
2).< Describe the Accounting and Auditing duties of the Comptroller and Auditor
General. ,
ii) ~ e r m of
s Appointment
The Constitution guarantees his/her salary and other conditions of service, which
.
cannot be varied to his/ her disadvantage after his/ her appointment. Also, the salary,
and allowances of the Comptroller and Auditor General, shall be charged on the
Consolidated Fund of India. Interference with the Comptroller and Auditor
General's function is likely, if the salary and terms of conditions of service are left to
the discretion of the Executive. Again, even in the event of Parliamentary displeasure
with a Comptroller and Auditor General, his/ her salary, pension or age of retirement
will not remain within the competence of Parliament to change, if it so wishes to
penalise him/ her. On his/ her retirement, resignation or removal, the Comptroller
and Auditor General is prohibited from holding any office under the Government of
India or under the Government of the State. The purpose is to keep the incumbents
immune from allurement of receiving favours from executive, which in turn might
influence his/ her actions or decisions in office, prior to retirement. Indirectly, this
provision strengthens the hands of the incumbents in making fearless assessment of
executive actions. In actual practice, the spirit of this provision does not appear to
have been strictly followed. The Constitution has provided that salaries, allowances
and administrative expenses of the Comptroller and Auditor General be charged
upon the Consolidated Fund of India. Unlike the other expenses of the Government,
his/her expenses will not be votable in the budget. Hence, his/her action and official
conduct is intended to be excluded from the scope of Parliamentary discussion and
vote. The Constitution has thus accorded a very strong protection against
Parliamentary interference with the working of the Comptroller and Auditor
General's organisation.
v) Limitations
Inspite of the various safeguards provided by the Constitution to maintain the
independence of Comptroller and Auditor General from the Executive and
Parliament, his/ her independence appears to be limited by four factors viz.,
(a) restraint of the Executive on his/ her budgetary autonomy (b) block of control over
staff (c) indirect accountability to the Finance Ministry of the Union and the Finance
Department of the State Government for handling accounting duties (d) absence of
direct access to Parliament (unlike the Attorney General) in defence of his/ her
official conduct, if and when questioned on the floors of Parliament.
To conclude, notwithstanding these limitations, the Comptroller and Auditor
General plays a unique role in rndian democracy, by upholding the Constitution and
the laws in the field of financial administration. He/She is neither an officer of
Parliament nor a functionary of Government. He/ She is one of the most important
officers of the Constitution and his/ her functions are as important as that of
Judiciary.
23.6 LET US S U M UP
As already mentioned, the Comptroller and Auditor General of India ensures the
supremacy of the Parliament over the Executive in financial matters. He/She is an
officer of the Constitution and not a n officer of the Parliament. The independence of
the CAG is guaranteed by the Constitution in many ways to enable him/ her to
-
perform his/ her functions without any inteference from the Executive. His/ Her Role of the Comptroller
and Auditor General (CAG)
primary duty is to uphold'the Constitution and the laws in the field of financial
administration.
Stores and Stock: The term "stores" applies generally t o all articles and materials
purchased or otherwise acquired for the use of Government. The term "stock" refers
to plant, machinery, furniture, equipment etc.
23.8 REFERENCES
Chanda, Asok; 1968. Indian Administration, G. Allen and Unwin: London.
Chanda, Asok; 1960. Aspects of Audit Control, Asia Publishing House: New Delhi.
Chandrasekhar R.K., 1990. The Comptroller and Auditor General of India, Ashish
Publishing House : New Delhi.
Ramayyar A.S., 1967. Indian Audit and Accounts Department, The Indian Institute
of Public Administration : New Delhi.
Sameer C. Mookejee, 1989. Role of the.Comptroller and Auditor General in Indian
Democracy. Ashish Publishing House: New Delhi.
- -
24.0 OBJECTIVES
After going through this unit, you should be able to:
explain the meaning 'and importance of financial administration in public
enterprises (PEs)
discuss the functions of financial administration in PEs
describe the financial objectives and organisation of PEs
explain the investment management and financing of PEs; and
evaluate the financial performance of PEs.
24.1 INTRODUCTION
Financial administration is the key functional area in the management of PEs.
The financial administrators of PEs have to interact continuously with the other
operating administrators in the enterprise to achieve the financial objectives.
Finance is a service function and, therefore, the counterparts of financial
administrators in other operating departments approach them to receive the
requisite decisional inputs to execute their responsibilities. In all the stages of
operations, finance function occupies the place of primacy. Under gestation,
finance is required for the implementation of projects. In the normal run of the
business, finance provides capital for meeting the day-to-day needs i.e., working
.capital. In expansion, finance provides resources both for current operations and
execution of new projects.
In this unit we shall discuss the meaning, importance, functions of financial
administration in PEs. The financial objectives and organisation of PEs shall be
dealt with. Various aspects of investment management and financing of PEs shall
be described. The financial performance of PEs in India shall be evaluated.
Planning Systems
The planning process in the enterprise includes strategic planning, long-term
corporate planning and annual performance budgeting. It also covers economic
and financial analysis needed for short-term decisions.
Strategic planning refers to planning of major strategies concerning expansion,
diversification, taking up manufacture of new products, entering new markets,
etc. The financial administrator plays a crucial role in marshalling the relevant
costs and benefits and in advising the management on the long-term financial
implications in terms of outlays and cashflows expected. HeIShe works closely
with the team engaged in the stratesic planning process. The criteria for investment
decisions mentioned earlier are integral to the process of strategic planning.
Long Range Corporate Planning is the process of developing a time bound plan
for achieving the objectives of an enterprise over a period of five or more years.
It takes into account all the on-going activities as well as the new projects being
taken up and prepares an integrated total plan for the enterprise as a whole.
Here again the financial administrator plays a major role in assimilating the data,
appraising the alternatives and developing master budgets and financial forecasts
for covering the plan period.
The Nrformance budget is an extension of the corporate plan. It is prepared in
greater detail and sets physical and financial targets for each responsibility centre
and builds the efficiency norms into them. The budget thus serves as an instrument
of planning and control. Since profitability is not the guiding index of efficient
performance, what is needed is a system for review and target setting for each
segment of the enterprise. The Management by Objectives (MBO) may also
provide a framework for formulating and implementing the performance budget.
These budgets enable decentralisation of authority and centralisation of wntrol.
Budgets also help management-by-exception.
Operating Decisions
There are very few decisions at the enterprise level which do not affect its funds.
It is, therefore, logical for the financial administrators to have a say in those
decisions. Leaving aside the investment decisions mentioned earlier the operating
decisions cover a wide range of problems such as capacity utilisntion, pricing,
overtime working,' shift-working, product-mix, credit policy and incentives.
Control Systems
Budgetary control and standard costing systems provide the basis for monitoring
enterprise performance at all levels. They introduce a participative element in the
target-setting exercise.
The financial administrator is expected to develop an integrated system which
, incorporatesfinancial accounting as well as management accounting systems. The
system has to be so designed as to generate data for compiling periodical reports
to be sent to the administrative ministry, Finance Ministry and Planning Commission
etc. It should also provide information to enterprise managers at all levels about
their achievements vis-a-vis plans and targets. These managers need assistance in
identijlng and analysing cost variance as well as profit variance.
Internal Audit is considered to be an integral part of finance function in most
of the PEs. It is internal appraisal and is mainly concerned with the evaluation
of the effectiveness of managerial controls including systems and procedures. The
external'auditors rely very much on the internal audit for ensuring the credibility
of basic records.
The financial executive coordinates with statutory auditors in carrying out the
external audit. PEs are audited directly by the Comptroller and Auditor General
of India (CAG) or by chartered accountants appointed by ,him as auditors. In
the latter case, he has powers to carry out a supplementary test audit. There is
an audit board which coordinates the external audit work in respect of central
PEs in India.
.......................................................................................................
Board of Directors
I
Chairman-cum-Managing Director
I
Direaor Director I Director
(Muction) (Marketing) I (Personnel)
I
I
Director (Finance)
1
Executive Director (Finance)
I
General Manager (Finance)
I
Deputy General Manager Deputy General Manager Chief (Fmance)
(CorporateF-CC) (Accounts) (One at each
I I UnitlRegion)
Finance Manager Senior Finance Manager
I I
~ e ~ F
u- & ~anqer Deputy Finance Manager
I
Senior ~ k u n t Officer
s
I
Accounts Officer
As the diagram shows, the Finance Division is headed normally by the Director
(Finance) who holds a board level position. He advises the Chairman-cum-Managing
Director (CMD) on all matters pertaining to finance and accounts. He is responsible
for formulating and coordinating the financial plans. He executes a staff function
and at the same time happens to be a line authority for the executive in the
finance department. He is assisted in his task by Executive Director (Finance)
and General Manager (Finance). The Executive Director is assigned some specific
tasks besides helping the Director (Finance) fi the formulation of financial policy.
These may include responsibility for audit and preparation of budget. The General
Manager (Finance) is saddled with routine affairs such as the preparation and
finalisation of accounts, compilation of budgets, handling of cash credit and
arranging corporate finance. In most of the PEs, the Director (Finance) is recruited
by the Public Enterprise Selection Board. The earlier convention of deputing the
officer from the Finance Ministry or the Indian Audit and Accounts Department
has been abolished by the government. Diagram 1shows that in case an enterprise
is a multi-unitlmulti-productconcern, the financial organisations provide for a
functionary (normally of the level of General Manager) to head this function at
the various locations or product groups.
In addition to the above delegation, Government (vide O.M. dated 7.11.88 and
29.8.1990) has further delegated enhanced powers to Board of Directors of
Memorandum of Understanding (MOU) signing companies'to incur capital
expenditure. As per the revised delegation, it has been decided that in respect
of companies signing MOUs and .having gross block of w e r Rs. 200 crore, the
I power to incur expenditure on additions, modifications and new investments will
b be raised from the existing limit of Rs. 20 more to Rs. 50 more without prior
1 approval of the government. Further, the power to incur expenditure on replacement
renewal of assets from the present limit of Rs. 50 crore to Rs. 100 more is
provided subject to certain conditions.
1 2 3 4 5 6 7 8 9 10 11
1. Number of
running Public
Enterprises Number 163 201 207 211 214 221 226 233 236
2. Crpital
Employed b.Crore 18207 29855 36382 42965 51835 55554 67629 84869 401797
3. Turnover b.Crore 28635 47272 54784 62360 69088 81271 93137 -1 118355
4. Gross Margin
(Rofit before
depruiation.
I intertn and
tax) . . b.Crore 2401 5771 7386 8230 9897 11134 13438 16412 18510
I
5. Dqmuuum*Rs.Crore 983 2205 2758 2983 3376 4150 4866 5790 7151
6. Gross profit
't before interest
and tax Rs.Cm 1418 3565 4628 5287 6521 6984 8572 10622 11359
7. Interest Rs.Crore 1399 20% 2529 3115 3420 3595 4167 5329 7539
8. Netpro6t
beforetax Rs.Cron 19 1480 2099 2172 3101 3389 4405 5293 3820
9. Tax b.Crore 222 1239 1190 Mob 1330 1329 1411 1504 1452
10.Net M t
after tax Rs.Crore -203 240 909 1172 1771 #)60 2994 3789 2368
11.Internal
Reso-
generated
(Grw Rs.Crore 1225 3278 4251 5068 6014 6947 8915 10774 llj72
12.Net M t
(after tax)
to capital
employed Percent -1.1 0.8 2.5 2.7 3.4 3.7 4.4 4.5 2.3
Table 2 shows that the position of the state level PEs was none too good.
These enterprises incurred losses continuously.
T.bb2:PLudrl-d-CouaeblU-dSt.baPrUTs
[profit(+)(Loss(-)I
(Rs. more)
4. Net FinMddR e d
-tdU- -547.92 -862.00 -1065.37 -1577.78 -1710.68 -1885.22 -2430.96
LET US SUM UP
PEs constitute an important segment of the economic system in India. Their
contribution to the national economy is phenomenal. Their effective functioning
is crucial for the success of the planned economic efforts. The effectiveness of
financial administration, measured in terms of profitability, points out that these
enterprises have lagged far behind the expectations. They can make significant
improvements in respect of the three components of financial administration viz.,
investment management, financing and checking upon their financial performance.
The function of financial administration is undergoing a sea change in PEs. These
enterprises have started organising their financial organisation in a businesslike
manner. They have commenced efforts to reduce their dependence on the
government through the capital market. They have initiated exercises to review
their investment portfolio to weed out non-operating assets. There is a great
scope for toning up, further the activities pertaining to financial administration in PEs.
24.11 REFERENCES
Department of Public Enterprises, 1991. Public Enterprises Survey, 1990-91,
Vol. I, Government of India, New Delhi.
Mishra R.K. 1992. Finance Function in Public Enterprise, Institute of Public
Enterprise, Hyderabad.
Mishra R.K. 1975. Problems of Working Cdpital in Public Enterprise,
Sornaiah: Bombay.
Mishra R.K. Nandagopal and N.C. Kar, 1987. Financing of Public Enterprises,
Institute of Public Enterprise, Hyderabad.
Objectives
Introduction
Concept of Financial ,Autonomy and Accountability in Public Enterprises
Tiers of Financial Autonomy and Accountability in Public Enterprises
The Methods of Ensuring Financial Autonomy and Accountability in Public
Enterprises
Status of Financial Autonomy and Accountability in Public Enterprises
Problems Pertaining to Financial Autonomy and Accountability in Public
Enterprises
Suggestionsfor Ensuring Improved Autonomy and Accountability of Public
Enterprises
~inancialAutonomy and Accountability of Public Enterprises: Recent Trends
Let Us Sum Up
Key Words
References
Answers to Check Your Progress Exercises
25.1 INTRODUCTION
The extent of financial autonomy and accountability has been at the heart of
discussions about improving the performance of PEs. There have been conflicting
views about the right mix of financial autonomy and accountability which can
ensure an efficient and effective performance from these enterprises. It goes
without saying that there is no well-defined formula available in this respect which
can be suggested to the principals (government) and the agents (PEs). What is
required is to inculcate an awareness about striking the golden mean between
financial accountability and financial control among those who hold the reins of
the government and PEs in their hands. The right mix will emerge as a result
of the mutualgnderstanding of the needs on the part of the principals and agents
and the restraints that both will impose on each other to find an agreeable
solution to the problem.
I
In this unit, we shall discuss the concept, various tiers and methods of financial
autonomy end accountability of PEs. The problems pertaining to this aspect will
be examined and suitable suggestions for improved autonomy and accountability
of P E s shall be nrovided.
Financial Autonomy and
25.2 CONCEPT OF FINANCIAL AUTONOMY Aceountnbiiity d PuMe
AND ACCOUNTABILITY IN PUBLIC Enterprlscs
ENTERPRISES
Public Enterprises (PEs) as we all know are set up wholly o r substantially owned
by the government for the purpose of undertaking activities of industrial,
manufacturing, trading or allied nature. They are government owned enterprises
functioning under both central and state governments. The PEs are corporate
bodies, set up either under specific acts of Parliament or under Companies Act.
The PEs since they are established with public funds, are accountable to the
public i.e. through thq parliament.
Autonomy in simple terms means freedom to take decisions and function accordingly
while accountability refers to rendering of accounts to some higher authority. The
financial autonomy given to PEs means empowering them to take decisions on
their own in the areas of investment management, financing of investments and
monitoring the financial performance of respective enterprises based on sound
business principles and the wisdom of the financial administrators. Insofar as
investments are concerned, other things remaining the same, PEs should have
freedom in identifying the projects, preparing the detailed feasibility project reports,
appraising the projects, making investment choices, and implementing and
monitoring them. They should also be free to decide the optimal level of investments
in the various items of inventory book debts and floating stock of cash. By the
same principle they should be free to peg the level of current liabilities to any
proportion of the current assets. The financial decisions in the normal run may
be made by these enterprises as guided by the cost of capital. They should possess
the freedom t o choose among the various debt-equity propositions. They should
be at liberty to select bankers, financial institutions and the channels of money
and capital markets for financing their working fund requirements. Subject to the
social constraints imposed on them by the government, these enterprises should
be vested with the autonomy to develop their own costing and pricing systems,
norms of profitability .and monitoring mechanism to ensure the desired financial
status alike any business firm in the private sector.
Prof. V. V. Ramanadham in his treatise entitled "The Control of PEs in India"
discusses the concept of financial accountability. Primarily it implies the accountability
of PEs to parliament in financial matters. So expressed, it is part of the general
problem of amenability of PEs to parliamentary control and calls for a compromise
between the democratic rights of parliament and the autonomy of the enterprises.
The other aspect of financial accountability is that the maximum good tesults
ought to be secured from the PEs. So expressed, it borders on the concept of
efficiency in financial terms. The maximisation is not tantamount to an insistence
on the highest possible profit from every public enterprise. The concept suggests
that, subject to any set criterion of profit and social benefit, the enterprise ought
to record the best possible results.
Check Y w Regress 1
Note: i) Use the space given below for'your answers.
1 ii) Check your answers with those given at the end of the unit.
1) What d o you understand by financial autonomy of PE?
.......................................................................................................
2) List six institutions which can explicitly lay down policy relating to financial'
i autonomy of PEs.
I .......................................................................................................
i
i
.......................................................................................................
.......................................................................................................
i
.......................................................................................................
# .
3) Point out the areas of financial accountability of PEs.
Financial Administration of
Public Enterprises
Articles 12 and 14 of the Indian Constitution have been extended to PEs whereby
these enterprises have been considered as State. The 'State' as defined in Article
12 of the Constitution, is to include "the government and Parliament of India
and the government and legislature of each of the states and all local or other
authorities within the territory of India or under the control of the government
of India". Though originally PEs were excluded from the purview of the 'State'
as defined in Article 12 of the Constitution, slowly, bodies performing
quasi-governmental functions, statutory corporations, government companies, have
been brought within the purview of the state. The High Courts and the Supreme
Court have accepted many writ petitions which have a financial impact on PEs.
Some of these relate to the procurement of materials and payment of pension etc.
As discussed earlier, PEs contain not only 'public' but the 'enterprise' element.
Thus to enable PEs function without any handicaps in the present competitive
atmosphere, there is a need to introduce an amendment in the Indian Constitution
to take PEs out of the purview of Articles 12 and 14.
2) What suggestions would you offer to strike a balance between financial control
and financial autonomy in PEs?
..........................................................................................................
..........................................................................................................
LET US SUM UP
Adequate financial autonomy is a necessary condition for the successful working
of PEs. This autonomy should not only flow from the government but it should
further percolate from the top to the bottom in the PEs themselves. The
financial controls are an important phenomenon in a democratic set up. These
controls should not, however, be regressive. Whereas there is an over emphasis
on financial accountability, PEs have failed in using whatever little leverage t
they have in respect of the financial autonomy.
KEY WORDS
- .
Articka of bmdatlon: These are regulations tor the managenlent,. .internal
.
arrangement of a company. It lays down the terms and conditions on wnicn tne
..-
shareholders, agree amongst themselves, as t o how the business of the company
shall be camed.
Capital Market: It refers to various institutions, arrangements concernea witn tne
purchase, sale and transfer of stock, bonds etc.
Depreciation: Dimunition or reduction in the value of an asset due to use and/or Financial Autonomy and
lapse of time. Accountability of Public
Enterprises
Debt-Equity Ratio: This ratio measures a company's financial leverage. It is
calculated by dividing debt of the company (both short and long term) by the
entire equity capital.
Contingency Fund: Refer to Section 8.5 of Unit 8.
Dividend: It is share of profits earned from a company either by the government
or any individual as holder of shares in that company.
Manuals: Documents in respect of the various subjects detailing the process and
the duties of the executives in carrying out various activities.
Management by Exception: It involves concentrating on those areas that are not
functioning according to plan rather than on areas of operation which are running
smoothly.
Management by Objectives: It involves managers and subordinates in jointly
establishing specific objectives and periodically reviewing progress towards meeting
those targets.
Marketisation: It denotes the governance of PEs by market forces in respect of
demand, supply and investment.
25.11 REFERENCES
Bureau of Public Enterprises and Bharat Heavy Electricals Ltd., 1988.
Government Policy on Public Enterprises Vol. I & 11, New Delhi.
Economic Administration Reforms Commission, 1985. Report on Autonomy and
Accountability in PEs, Government of India: New Delhi.
Iyer, Ramaswamy R, 1991. A Grammar of Public Enterprises, Exercises in
Clarification, Rawat Publications: Jaipur.
Nigam Raj K, 1986. Towards a viable and vibrant Public Sector in India,
Documentation Centre for Corporate and Business Policy Research: New Delhi.
Sankar, T.L., R.K. Mishra, S. Ravisankar, 1983. Public Enterprises in India,
Himalaya: Bombay.
Sankar, T.L., R.K. Mishra, S. Ravisankar, 1984. Leading Issues in Public
Enr~rpnst'sManagement, Himalaya: Bombay.
Sankar, T.L., D.J. Chambers et.al, 1986. Public Enterprises Policy in India and
UK in 1980s, Himalaya: Bombay.
26.0 OBJECTIVES
After studying this Unit, you should be able to:
. explain the major divisions and the machinery concerned with financial
administration
discuss the ecology and principles of urban local finance
explain the sources of municipal revenue and expenditure pattern
describe the budgetary process and the system of accounting and auditing
I highlight the methods of state control over municipal finance; and
evaluate the causes of gap between the municipal services and resources and make
suggestions to bridge the gap.
I
I 26.1 INTRODUCTION
De Tocquaville, a noted French writer pronounced "A nation may establish a system
of self-government, but without the spirit of municipal institution it cannot have the
spirit of liberty". Former Prime Minister of India, the late Jawahar La1 Nehru
remarked "Local self government is and must be the basis of any true system of
democracy. We have got rather into the habit of thinking of democracy at the top and
not so much below. Democracy at the top will not be a success unless you build on its
foundation from below." Thus local institutions constitute the strength of a free nation.
At the local level, India is governed by two different sets.of institutions, namely, the
Rural Governments and the Urban Local Governments. The former covering the
rural population, comprises a three-tier structure from the village to the district. It
was recommended by Balwantrai Mehta Committee. It is formed on democratic
principles and organically linked. The urban local governments cover urban
population. The requirements for an urban area are:
Local Finance a) a minimum population of 5,000
b) a population density of not less than 400 per sq. km., and
c) three-fourth (75%) of the occupations of the working population should be outside
agriculiure.
The first five are created under state Municipal laws while the Cantonment Boards are
established under central Act, called Cantonment Act, 1924. Since local government is
a state subject (entry 5, state list, seventh schedule of the Constitution of India), local
bodies are created by the respective state governments. The pattern of local
governments, therefore, varies from state to state. Even within the state all the six
types are not found in every state. But municipalities are found everywhere.
Financial administration in urban governments is as important as finance. It consists
of those operations the object of which is to make the best use of available resources
and channelling them into proper fields of expenditure. Under democratic
government, the elected institutions (i.e., Municipal councils in case of Municipalities)
vote the taxes and authorise expenditure. It has to ensure that these representative
institutions do not place more tax burden on the people and the money voted by them
for expenditure is used according to their wishes with due regard to economy and
efficiency. An ill-organised financial administration can be a handicap resulting in
inadequate finances.
Financial administration in urban governments falls into the following divisions:
i) Preparation of the budget i.e., estimates of revenue and expenditure for ensuing Y
financial year
ii) Getting budget passed by the Municipal council or other competent authority
iii) Regulation of the expenditure and raising resources according to it !
The form of local polity, size and level of local units, local functions, government
control and the economic conditions of local inhabitants are important factors which
contribute to determining the ecology of local finance. The financial position of the
local government is significantly determined by the form of local polity. A
decentralised pattern of local government helps the local authority to determine its
financial position because it enjoys greater degree of financial independence to levy,
,..n-nn n-rl ,.,liar+ +,van ..l,,, ..Art. ,..G,:,-b C-,,AA, r - C---..l,b, l-,:-l,c, -,A
execute budgetary proposals. Whereas, a deconcentrated pattern of local government
may not help the local government to augment its financial resources because it allows
a lesser degree of financial autonomy in regard to various facets of its financial
activities. In this type of local polity, local government heavily depends on the
government-for finances. It may also not command better public image and enjoy
better position in relatio'n to government when compared with local government in a
decentralised polity.
Another important factor which determines the adequacy of local finance is the size of
the local authority. A local unit, big in terms of its area and population, has a better
financial position in comparison to the one that is comparatively small in terms of
physiography and human settlement. Take for example, in comparison to.a Municipal
Corporation, a Notified Area Committee has limited sources of income because of its
small area and population. Such types of local authorities look to upper levels of
government for help to keep themselves financially in a viable condition.
Responsibilities given to the local government are yet another prominent factor for
determining the local finance. The government allocates resources to the local
governments commensurate with their functions. Where the local government fails to
carry out its responsibilities within the available resources, the government has to
either provide extra revenue or withdraw such responsibilities. In India, for example
primary education is a local function. But sometimes inadequate local finance does
not permit most of the local authorities to perform this function inviting government
intervention. Moreover, when new responsibilities are assigned to local bodies,
adequate funds are made available to the local government in the form of government
grants.
Last but not least the general poverty of our people is undoubtedly a potent factor in
the matter of local finance. People in our country have very little taxable capacity. A
simple study of the annul national per capita incomes of countries like - UK, USA,
Canada and Japan and that of India will amply prove the point. Thus, general
poverty\of people may not help to contribute much towards local revenues.
The principles which should govern urban local finance are discussed briefly as under:
The entire financial system of urban governments should be well-integrated and all
fiscal arrangements should combine into a consistent whole. The integration of
central, state and local revenue and expenditure should be done in such a way that
promotes development. The coordination of central, state and local finance should
not only be in taxation but should also cover the current budget, capital outlay
programmes, credit operations of the various authorities and should be accompanied
with a coordination of their administrative activities as well.
Fiscal Access
The fiscal arrangements should be such that they give to urban governments an access
to new financial resources. There should be no bar: in developing new sources of
income within their own prescribed fields to meet the growing financial needs. The
resources should grow as the responsibilities increase, hence, the need for exploiting
new sources of revenue.
Loans
Urban governments also meet their needs of capital expenditure such as purchase of
land, heavy machinery and long-term projects by raising loans. Borrowings are
regulated by the central law known as Local Authorities Loans Act, 1914. Loans are
raised with prior sanction from the state government. In certain cases, the permission
of the central government is also needed. The urban governments are permitted to
borrow loans from banks, Life Insurance Corporation and other financial institutions.
All proposals concerning loans from open market or LIC are required to be cleared ,
by the Reserve Bank of India. For all practical purposes, urban governments except
municipal corporations have to depend largely upon loans from their respective state
governments. Every loan has its own rate of interest, term, mode of repayment,
measures of utilisation etc.
A municipality can spend on the services permitted to it under the law which may be
contained in a public Act of Parliament or State Legislature in a local Act. Besides,
the state government may, in the name of public interest, declare any other
expendituqe to be a legitimate charge on municipal funds. Though the responsibilities
of municipal bodies in our country are more or less similar, yet there are wide
variations among the states in the matter of per capita expenditure on different heads
or services. The important heads of municipal expenditure are as under:
Public Education
The responsibility of providing free and compulsory education for children until they
complete the age of fourteen years is as a matter of fact to be borne by the state
governments. (Article 45 of the Constitution of India). But in some states, like
Punjab, Bihar, Haryana, Uttar Pradesh, this is being shared by urban governments.
These states extend financial aid to urban governments to meet the expenditure. The
expenditure on public education falls under two heads, viz., (1) running schools, and
(2) setting up and operating public libraries and reading rooms.
Medical and Public Health
Protection of public health is one of the primary functions of urban governments. The
public health activities are divided into two parts:
i) provision for medical relief and administration of preventive.medicines and
ii) maintenance of public health.
Water Supply
Pure drinking water is essential for good health. The provision of pure, clean and
adequate water supply is, therefore, an important function of urban governments.
Expenditure on this head is usually quite heavy because tanks, reservoirs, engines,
pipes, taps and other works may have to be constructed and maintained. Besides, the
water is supplied at no-profit no-loss basis, in other words, the water is supplied at a
less rate than the cost of production.
Municipal Works
It is one of the important items of the municipal budget. Under this head, the urban
government's maintenance of roads, bridges, markets, slaughter-houses, lanes and
bye-lanes and any such other works concerning with the physical beautification and
development of the city or a town, are covered.
...............................................................................................................................
2) Describe briefly the principles which should govern the local finance.
............................................................................................................................... Financial A d d d S U a h d
............................................................................................................................... Urban Covernmencs
...............................................................................................................................
3) Explain the sources of income of urban government.
...............................................................................................................................
...............................................................................................................................
...............................................................................................................................
. '
Stores
Urban Government's stores are divided into two parts, namely, (a) Special stores
and (b) General Stores. Special stores consist of article required by a particular
I
department. These are purchased directly according to the requirements of the
department. General stores consist of articles which are of general bse and are
required by general departments. Such stores are purchased through the central stores
department. In this way the purchase of wholesale quantity is made at the lowest rate
Local Finance and much saving is effected in cost as well as in establishment charges.
-
26.7 STATE CONTROL AND SUPERVISION i
Urban local bodies are not sovereign bodies. As mentioned earlier, local government
is a state subject and as such state government is empowered to legislate on various
aspects of local bodies. It determines their structure, powers, functions, financial
resources etc. In fact, urban local bodies are regularly controlled, supervised, directed
and occasionally penalised by the State Government for their acts of omission and
commission. In India, the forms of government control over urban bodies are many
and varied. Such control is of four broad varieties, namely, (a) legislative, (b) judicial,
(c) administrative, and (d) financial. In this unit, we are mainly concerned with
financial control. Government control over the finances of urban governments may be
grouped under the following heads.
State government may allow urban bodies to add supplementary rates to the existing
government taxes. For example, in India, when state governments had abolished
octroi, they permitted the urban governments to impose a surcharge on the sales tax
which is a state tax: Besides, a local tax may be administered by the government,
although it is actually enjoyed by the urban governments. For instance, in Andhra
Pradesh entertainment tax which is basically a local tax is imposed by the government
but the entire proceeds are given to urban governments after retaining the collection
charges amounting to Rs. 5 per unit of the collections. Similarly, from motor vehicle
tax, which was formerly a local tax in India, certain percentage of the collections are
made over to the urban authorities by the state governments.
The urban bodies are required to prepare their budgets in the manner and form as
determined by the state government from time to time. The budget approved by the
municipality canriot be executed without the prior sanction of the state government
which in turn has the power to make alterations in budgetary proposals. As
mentioned in the preceding section if municipality does not agree with the
modifications made, the decision of the state government is final'and binding on the
municipality. In some states, the budget is not subject to the sanction of the state
government. In such states the approval is needed only in those cases where
municipalities are indebted. Besides, prior sanction of the state government is also
needed for re-appropriation from one head to another head of the budget, that is, the
money granted for education can be put to use for public works with government
approval.
utilised and not misappropriated or diverted to unapproved purpdses. The grants can
be reduced, suspended, and withheld if the accompanying conditions are not fulfilled
by a municipal body.
26.8 GAP B E T ~ E N
MUNICIPAL SERVICES AND
RESOURCES
The municipal resources are mainly based on the distribution of functions between the
State Government and the Local Government. The functions of the urban
governments are specified in the Act under which they are established. The municipal
functions are categorised as compulsory and optional. In order to discharge obligatory
functions budgetary provision is made for them. If urban bodies fail to perform
obligatory functions, the state government helps them either by providing grants-in-
aid or arranging long-term loans to meet the needs, subject to their repayment.
Howtver, an analysis of the mnnicipal resources shows that there is a wide gap
between the municipal services and resources.
In India, the entire field of municipal resources, remarks one commentator "is replete
with outmoded principles of political economy, with stultifying checks and with
consequential discouragement." There is an overall lack of appreciation of the fact
ihat adequacy of financial resources and efficiency of financial management are
determinants of the tone of municipal administration. The causes of inadequate
municipal resources are of varied character. The entire machinery of municipal tax
administration suffers from serious defects such as poor collection, heavy arrears,
leakage of revenue, corruption, evasion in taxes, improper assessment of taxes etc.
Further, the municipal personnel are low-paid and lack necessary training and
experience. It has been observed that the local staff concerned with the assessment of
taxes is generally not fair and the principle of equity is often disregarded. For
instance, the Tax Superintendent being responsible to the members of the municipal
committee is generally inclined to assess the houses of influential persons and the
members at a low rate.
In spite of the audit of municipal accounts, the audit has remained ineffective and
inefficient. ~ x c e in~ big
t municipalities, audit is not conducted regularly. It is
generally in the nature of post-mortem examination which is sometimes dubbed as
"locking the stable after the horse is stolen." Again audit objections and reports
remain uncared for, at year's end. Thus the very purpose of the audit is frustrated.
The borrowing powers of the urban local bodies in India are also limited. The term of
re-payment and the rate of interest on loans are unfavourable in comparison to
developed countries of the World.
Further, most of the sources assigned to municipal bodies for taxation are inelastic
and cannot provide the required services for the growing activities of these bodies.
For exampie, taxes like octroi, terminal and property which constitute the backbone
of municipal finance are quite inelastic as the proceeds from them do not grow in
proportion t o the growth in financial mquirctan&ts. Tbe rules and procedures
governing the imposition of taxes etc. are very elaborate, cumbersome, time
consuming and leave very little financial independence to municipal bodies. Besides,
the powers of the Indian local bodies to levy is limited by the Constitution of India.
For instance, Art. 285(2) of the Constitution exempts the Central Government Financial Admlnhlration of
Urban Governments
properties from the levy of local tax by municipalities.
One of the contributing factors to the poor municipal resources is that the
government grants are utterly inadequate, unrelated to needs, irregular, unsystematic
and uncertain in their release to municipal bodies. In some states, like Punjab and
Haryana, government has taken over some of the municipal functions or the-
administrative control thereof as in the case of education and f re-brigade but the
t
expenditure pertaining to these functions is largely borne by th municipal bodies.
This is wholly unfair and unbusinesslike.
Another significant reason for inadequate financial resources is the unwillingness of
municipal bodies to mobilise their resources to the admissible limit and to exploit
even the limited powers of taxation that they have. They have, generally, shown
utmost reluctance in increasing the existing taxes or in imposing new ones even where
advisable and feasible, especially the direct taxes, for fear of people's anger and
resentment.
Apart from the above mentioned causes for the unsatisfactory position of municipal
resources the other reasons are: underdeveloped trading enterprises, increased
population pressure, general poverty in India, increased responsibilities, increased cost
of municipal services because of eversoaring prices of the material and enhanced
wages of the municipal personnel, and so on.
If the municipal government is to play its role commensurate with the expectations
and aspirations of the people, a serious effort is to be made to ensure its financial
soundness so that the gap between the municipal services and resources is reduced.
A number of committees and commissions have examined the question of the
adequacy of municipal resources in India since independence. It has been suggested
that the prevalent reluctance of municipalities to introduce taxes has to be overcome.
The local Finance Enquiry Committee (1949-5 1) rightly recommended "Local bodies
which do not utilise their existing power of taxation can have no claim on the
financial resources of the state, where a local body is unwilling to impose tax at an
adequate rate, the state government should have the right, in first instance, to give
friendly advice and if the local body fails to carry it out, the state government should
in the last resort, have the power to impose or raise the taxes. To augment the
resources of municipalities, the financial management of these bodies needs to be
streamlined, by selecting municipal personnel on merit, imparting them adequate
- training, paying them competitive salaries etc. Apart from this, there should be a strict
check on the corrupt and defaulting employees. Efforts should also be made for the
proper assessment and collection of taxes. Incentives may be offered for prompt
payment of taxes and heavy fines may be imposed on the tax defaulters. Besides, audit
should be conducted more regularly and special provisions even punitive in nature
should be made for the speedy disposal of audit objections.
........................................................................................
2) What are the various methods of state control over municipal finance ?
........................................................................................
.......................................................................................
3) critically evaluate the gap between municipal services and resources.
Deconcentrated Pattern
In a deconcentrated pattern, a government o r an organisation unit o r a superior
delegates t o another, the power t o act in its o r his o r her name without transferring
the authority. It resewes its authority to withdraw it a t any time, o r issue directions
and even t o reverse the decisions. In fact, the delegated authority is not a right but a
derived concession that also can be exercised at the pleasure of the delegating
authority. Thus, in this type of pattern, the local authorities merely act as agents of
Central or State Government.
Decentralised Pattern
In a decentralised pattern, there is devolution of powers from one government t o
another by means of either a statute o r Constitution. It is just an extension of the
-
democratic principle extension of people's right t o manage their own affairs in a
local area without any undue interference from central o r state government. Thus, in
this pattern, local authorities have a right and not a concession of independent
existence .and functions.
Ecology
The word 'ecology' is borrowed from biology where it suggests the interdependence
between an animal species and its natural environment. In public administration, the
concept of ecology means the study of interdependence or interaction between public
administration and its environment. Since, local government'is a part of the public
administration, it cannot escape from theeffectsof environment in which it develops.
Notifled Area Committees: These are set up to meet the civic needs of the developing
towns, which do not fulfil the statutory conditions for the constitution of a
municipality. These are entirely nominated bodies and such provisions of the State
Municipal Act apply todhem as are specified by the state through a notification. ' 5
Octroi Tax
It is a tax on go6ds which are brought into the municipal limitsfor consumption, use
nr pale therein
Local Finance Terminal Tax
It is imposed on goods arriving in a city or town by rail. It is realised by the railway
on behalf of the municipality, on commission basis.
Town Area Committees : These Committees are of smaller size. These exist in smaller
towns and are entrusted with limited civic functions. These are governed under special
statute.
26.11 REFERENCES
Maheshwari, Shriram, 1984. Local Government in India, Lakshmi Narain Aggarwal:
Agra.
Sharma, S.K. and V.N. Chawla, 1975. Municipal Administration in India: Some
Reflections, International Book Company.
Singh, S.N., 1991. Local Government: A Comparative Perspective, Uppal Publishing
House: New Delhi.
Thavaraj, M.J.K. 1978. Financial Administration of lndia, Sultan Chand and Sons :
New Delhi.
27.0 OBJECTIVES
After studying this unit, you should be able to:
describe the machinery concerned with financial administration in rural
governments
discuss the concept of rural development and the principles of rural local finance
examine the sources of revenue and expenditure pattern of rural local authorities
explain the various aspects of rural fiscal management
evaluate the forms of state control and supervision over Panchayati Raj finances;
and
highlight the gap between the rural services and resources and-suggest remedial
measures to narrow the gap.
27.1 INTRODUCTION
In India, Rural Local Government covers the rural population. It is created,
sustained, regulated and even abolished by the State Government. It consists of three-
tier structure, namely, Village Panchayat at the village level, the Panchayat Samiti at
the block level, and the Zila Parishad at the district level. It was recommended by the
Balwantrai Mehta Committee and is based on the concept of democratic
decentralisation which was later on termed as Panchayati Raj in preference to Rural
Government.
Keeping in view the importance of local self-government in free India, a provision was
made in the Constitution for the growth and development of Gram Panchayats.
Article 40 lays down: "The state shall take steps to organise village Panchayats and
endow them with such powers and authority as may be necessary to enable them to
function as units of self-government". Apart from this, Article 246 also empowers the
State Legislatures to make laws with respect to any matter pertaining to local self-
government. The extent and form of democratic decentralisation, therefore, varies
from State to State. At present, there are various models of Panchayati Raj operating
in the country. Some states like for example, Andhra Pradesh (from 1959 to 1983),
Rajasthan had adopted the three-tier structure of Panchayati Raj as recommended by
Balwantrai Mehta Committee. But in Andhra Pradesh, on the basis of Asoka Mehta
Committee recommendations, a four-tier structure came into existence since 1983,
with Mandal Praja parishads coming in place of Panchayat Samitis. In Maharashtra
too, the pattern of Panchayati Raj is unique, wherein instead of block, district has
been made the unit of planning and development, while Panchayat Samiti acts as a Financial Administration of
Rural Covmments
statutory committee of the Zila Parishad. In Karnataka since 1985, changes were
brought about in the earlier prevailing three-tier structure. Now there are Village
~ a n c h a ~ a t s / ~ oPanchayats
wn at the base, the Taluka Development Boards in the
middle and the District Development Council for each district at the top.
The 1980s saw the resurgence of rural local bodies in India, particularly in Andhra
> Pradesh, Karnataka and West Bengal. The Union Government had also come up in
May 1989, with a bill in favour of aConstitutiona1.amendmentfor the resurrection of
Panchayati Raj, backed by the slogan "Power to people" and got it passed in the Lok
Sabha. The bill could not become an act as the sponsors failed to muster the required
support in the Rajya Sabha. Again in 1990, the 74th Constitutional amendment was
introduced by the National Front government which lapsed due to the dissolution of
Lok Sabha.
Financial administration in Rural Local Government involves operations designed to
. generate, regulate and distribute the financial resources needed to provide services to
the community. These operations are performed by the following agencies:
i) The Executive Wing which prepares the budget
ii) The Legislative Wing which alone can grant funds
iii) The executive, which controls the expenditure of funds sanctioned by the I
Legislative Wing
iv) The Audit Department
v) Standing Committees especially the Standing Committee for Finance and
Taxation.
All governmental programmes would remain mere paper items in the absence of
adequate financial resources. As a matter of fact, government cannot achieve any of
its social and economic goals without requisite finances. Thus, it can safely be
concluded that finances are sine qua non for the success of Panchayati Raj. The
pattern of revenues of Panchayati Raj varies from State to State. But the sources of
revenue of Panchayati Raj Institutions, in general, may be grouped under: (i) Tax
Revenue, (ii) Non-Tax Revenue, (iii) Grants-in-aid, (iv) Loans, (v) Share of State
Taxes, and (vi) Donations and Contributions.
Non-tax revenue
The non-tax revenue of Panchayati Raj consists of:
a) fees at fairs, agricultural shows etc.,
b) fees for use or benefits derived from public hospitals, dispensaries, markets etc.,
c) licence fees
d) Judicial fines .
e) remunerative assets
f) rents and profits accruing from property vested in or managed by Panchayati Raj
Institutions and
g) income from trusts, endownments, gifts.
Grants-in-aid
In Zlll the States, the Panchayati Raj Institutions depend heavily upon the grants from
the state governments. Grants-in-aid given by the States are ad hoc and discretionary
in nature depending largely on the availability of funds with the States. These can
Financial Administratiom of
broadly be divided into two categories-general purpose grant and specific purpose Rural Governments
grant. The former is released to Panchayati Raj Institutions to meet their general
expenditure. The latter grant is earmarked for certain specific purposes such as water
supply, flush type latrines, sewerage system etc. In India, the pattern of grants-in-aid
varies from state to state. In Punjab, the Panchayat Samitis receive the following
grants from the State Government:
1) Compensatory grants in lieu of abolition of tax on profession, country liquor,
cattle pounds.
2) Grants for implementing Community Development programmes.
3) Grants for the performance of agency functions.
4) Ad hoc and matching grants.
5 ) Grants from other departments such as animal husbandary, education, health and
family welfare.
Panchayati Raj Institutions raise loans to meet the capital expenditure involved in
satisfying the increasing local needs which are developmental in character. In India,
local borrowings are regulated by an ~ll-1ndiaAct known as the Local Authorities
Loan Act of 1914. The State governments may impose different forms of restrictions
on Panchayati Raj Institutions to raise loans which vary from State to State.
communications, animal husbandry, family welfare, salaries of the staff, audit fee, law,
charges, repayment of loans etc. Table given below shows the expenditure on different
heads, incurred by the Panchayat Samiti in Chandigarh during the year 1987-88.
'
Local Finance Expenditure Pattern of Pmcbayat Samiti in Chmdigarb
Head of Account
Establishment
* 1987-88
Rupees)
.. --
Finamid Administration of
Budget preparation and its approval Rmrl Gorcranwats
In Panchayati Raj Institutions, budgeting is one of the major processes by which the
use of the public resources is planned and controlled. The budget plays a very
important role in the social and economic life of a community. In India, the long-term
objectives of the Five Year Plans of the Government influence the revenue and
expenditure pattern of Panchayati Raj Institutions as shown in the annual budget.
Every year, the Gram Panchayat prepares its budget towards the year-end. The
Sarpanch and the Panchayat Secretary in consultation with Panchayat members
attempt to frame the budget which is placed before the Gram Sabha at its Sawani
meeting for consideration and suggestions. In case, a Gram Panchayat fails to prepare
the budget, the respective Panchayat Samiti prepares the budget and places it before a
specially convened meeting of the Gram Sabha concerned for necessary action. it may
be clearly noted that Gram Sabha has only to consider the budgetary proposals
placed before it. It does not have the power to formally pass them. Generally it is
passed in the form of a resolution and sent to the respective Panchayat Samiti for its
sanction. Thus, it can be said that if Gram Panchayat defaults, the respective
Panchayat samiti is the formal authority to frame and finalise its own budget.
The budget estimates of receipts and expenditure of Panchayat Samiti are drawn up
by the Executive Officer (B.D.P.O.). These estimates contain the (a) actuals of the
previous year, (b) budget estimates for the current year, (c) revised estimates of the
current year, and (d) budget estimates of the next year. The Executive Officer
endeavours to prepare the estimates as accurate and realistic as possible and keeps in
view amounts which are expected to be received by the Panchayat Samiti from the
Government by way of grants-in-aid for Community Development Programme and
schemes transferred by other departments of the State Government. After careful
scrutiny of the budget estimates by the Executive Officer, it is submitted to the
Standing Committee on Finance and Taxation for its close scrutiny or any
modification as it may consider fit. After the scrutiny by the Committee, the budget is
again submitted to the Panchayat Samiti for consideration, which may approve the
budget with or without any modification. The budget so approved is sent to the Zila
Parishad which may or may not suggest any alteration in the budget. In Punjab, in
case of difference of opinion, the decision of the Zila Parishad is final and binding on
the Panchayat Samiti. But the situation differs from state-to-state. Even in the case of
Punjab, the differences are generally resolved at the political level.
The Secretary of the Zila Parishad prepares the budget every year and places it before
the Standing Committee for finance and taxation. After having considered the
estimates of receipts and expenditure, the standing committee submits the budget to
the Zila Parishad for approval. As soon as it is passed by the Zila Parishad, it is sent
to the government so that it can be scrutinised with a view to pointing out any misuse
or abuse of funds placed at the disposal of the Zila Parishad. Thus, it is clear that the
budget as passed by the Parishad is final.
Apart from this, it is important to note that the departments cancerned prepare the
District-wise statement of funds to be placed at the disposal of the Zila Parishads and
the Panchayat Samitis and pass on the same to the State Government before the
prescribed date each year. The Government communicates to each Zila Parishad the
allocation af funds for schemes earmarked to the Zila Parishad as well as Panchayat
Samitis. The Zila Parishad then meets immediately and decides block-wise allocation
of funds and conveys its recommendations to the government. Keeping in view the
recon'mendations of the Zila Parishad, the government communicates to each
Panchayat Samiti the allocation of funds allotted to it for the schemes to be executed
by it during the next financial year. On receipt of the intimation of the allocation of
funds, the Panchayat Samiti prepares its budget and submits it to Zila Parishad for
approval as mentioned earlier.
In order to collect taxes, a fresh Demand Register is prepared every year. The nature
of demand, name and address of persons by whom tax is payable etc. are entered in
the register. If an assessee feels that an assessment of his liability to a tax is not
correctly and fairly made, he is entitled to make objections within a prescribed period,
usually before the assessing officer himself. If he is not satisfied with the decisions on
his objections, he is usually entitled to appeal to some higher officer. The detailed .
procedure in regard to arrears, refund of taxes, receipt of payment by cheque etc. is
laid down in rules framed by the State Government.
Stores
The term 'Stores' includes all articles and materials purchased or otherwise required
for the use of or in the service of Panchayat Samiti or Zila Parishad, whether these are
,consumable like articles of stationery etc., or non-consumable like instruments,
furniture etc. Detailed rules have been framed for the procurement, custody and issue
of stores.
Panchayati Raj Institutions like urban local bodies are non-sovereign entities. Though
authority and responsibility have been transferred to these institutions, under
democratic decentralisation, they do not enjoy absolute autonomy to manage their
own affairs. They function under varied forms and degrees of control exercised by the
respective state governments. Had they not been under any control, they would not
have been local authorities, but sovereign states. The main purpose of the government
control is to assist, guide and direct these institutions so that they do not make
mistakes. This is what Mehta Committee observed. "It must not be cramped by too
much control by the government or government agencies. It must have the power ro
make mistakes and to learn by making mistakes, but it must also receive guidance
which will help it to avoid making mistakes" State Legislature exercises legislative
control government departments, exercise administrative control, and the courts,
exercise judicial control. In his Section, we will examine the financial control
exercised by the government or government agencies over these institutions.
Financial control is one of the most effective instruments of government control over
Panchayati Raj Institutions. This type of control is more or less similar in almost all
the states and is exercised in matters relating to taxes, budget, grants-in-aid, loans,
accounts and audit. The taxation powers of the Panchayati Raj Institutions are
strictly controlled by the government. Every resolution of each unit of Panchayati Raj
to increase or decrease the rate or even to abolish an existing tax needs the approval
of State Government. In Punjab, the government is empowered to permit Panchayat
Samitis to impose tax on any subject of the state list. The government may even
suspend or abolish a tax which it considers to be unfair in its incidence or injurious to
public interest.
In all the states, detailed accounting procedures have been laid down in matters
pertaining to itemisation of receipts and expenditure, custody and disbursement of
funds, stores, periodical scrutiny of accounts by the appropriate authorities, and so
on. Besides, the accounts are also subject to government audit which is an important
instrument through which control and supervision is exercised, deficiencies located
and loop'holes plugged to ensure financial discipline. As mentioned in the preceding
section, there is also a provision for pre-audit or test check of the accounts of
Panchayati Raj Institutions by the auditors appointed by the State Government.
The State Government has a financial stake in Panchayati Raj Institutions. It provides
Local Finance natural that the provider or guarantor of funds has a responsibility to ensure that they
are not misused or diverted to unapproved schemes. Thus one who pays the piper
calls the tune. Besides, every proposal to raise loan requires approval by the state
government. Before government gives the green signal t o borrow, it examines the
scheme in detail, reviews the entire financial position of the unit of Panchayati Raj
concerned, fmes the period of repayment, determines the mode of borrowing etc.
Budgets are to be prepared by the Panchayati Raj Institutions in the manner and form
as prescribed by the state government, which may also frame rules in regard to the
time schedule for the submission of budget to higher authorities. In some states, it is
'
the superior tier of the Panchayati Raj that has the power to sanction the budget. For
instance, the budget of the Gram Panchayat is approved by the Panchayat Samiti and
Samiti's budget by the Zila Parishad. The system of supervision within the three-tier
structure is an important feature of democratic decentralisation envisaged by the
Balwantrai Mehta Committee which also recommended that village panchayats
should be supervised by the Panchayat Samitis, the Samitis by the Zila Parishad and
the Zila Parishads by the State Government. All this was to be in addition to the
powers of the Deputy Commissioner and other State officials who exercise similar
powers of supervision. Last but not the least, the state government is empowered to
either supersede or dissolve the Panchayati Raj Institutions on the grounds of
persistent maladministration, corruption, misappropriation of funds etc. It is the
ultimate weapon in the armoury of the state government to put the Panchayati Raj on
rails.
.........................................................................................
........................................................................................
3) The problems of Panchayati Raj finance are varied in nature-Discuss.
........................................................................................
........................................................................................
........................................................................................
27.11, REFERENCES
Bhatnagar, S., 1978. Rural Government in India, Light and Life: New Delhi.
Durgesh Nandini, 1992. Rural Development Administration, Rawat Publications:
Jaipur.
Financial Administration of
Maheshwari, Shriram, 1971. Local Government in India, Orient Longman: New Rural Covemment~
Delhi.
Muttalib, M.A., and Mohd. Akbar Alikhan, 1982. Theory of Local Government,
Sterling Publishers Private Limited: New Delhi.
Reddy, G. Ram, 1977. Patterns of Panchayati Raj in India, Macmillan: Delhi.
Fiscal access
3) Your answer should include the following points:
Tax revenue
Non-tax revenue
Grants-in-Aid
Loans
Share of State Taxes
Donations and contributions
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