QUALITY OF PUBLIC EXPENDITURE: ECONOMY

QUALITY OF PUBLIC EXPENDITURE: ECONOMY

NEWS: How India improved the quality of its govt expenditure — and why that matters

 

WHAT’S IN THE NEWS?

The Reserve Bank of India (RBI) has reported that the quality of public expenditure in India, both at the Centre and state levels, is at its highest since the economic reforms of 1991.This assessment is based on various fiscal and expenditure indicators, emphasizing the importance of capital expenditure (Capex) over revenue expenditure.

 

Fiscal Discipline in India: The FRBM Act

1. Introduction of the FRBM Act (2003)

  • The Fiscal Responsibility and Budget Management (FRBM) Act was enacted in 2003 to ensure fiscal discipline by limiting excessive government borrowing and improving financial stability.
  • The Act aimed to maintain sustainable public finances while ensuring efficient utilization of government funds.

2. Key Objectives of the FRBM Act

  • Fiscal Deficit Limit:
  • The fiscal deficit (the difference between government expenditure and revenue, financed through borrowing) was capped at 3% of GDP.
  • Revenue Deficit Target:
  • The goal was to eliminate the revenue deficit, ensuring that government borrowings were used only for capital expenditure (infrastructure, development projects) and not for recurring expenses like salaries and subsidies.

3. Shift from Fiscal Deficit Focus to Debt-to-GDP Ratio

  • Over time, India has shifted its focus from just maintaining a fiscal deficit limit to managing the overall debt-to-GDP ratio.
  • This ensures a more comprehensive approach to fiscal health, balancing debt sustainability and economic growth.

 

Importance of Capital Expenditure (Capex)

1. What is Capital Expenditure?

  • Capital expenditure refers to government spending on infrastructure, industrial development, healthcare, education, and other long-term assets that enhance economic productivity.

2. Why is Capital Expenditure Preferred Over Revenue Expenditure?

  • Stimulates Economic Growth:
  • Investments in infrastructure and productive assets create jobs and boost economic activity.
  • Enhances Long-term Development:
  • Unlike revenue expenditure (which covers salaries, pensions, and subsidies), capital expenditure improves national productivity.
  • Strengthens Fiscal Sustainability:
  • Capital investments help generate future revenue streams, reducing reliance on borrowing.
  • Supports Private Investment:
  • Government investment in infrastructure crowds in private investment, leading to a multiplier effect in economic growth.

 

Quality of Public Expenditure in India: RBI’s QPE Index

1. What is the QPE Index?

  • The Quality of Public Expenditure (QPE) Index is a framework developed by the RBI to assess how effectively government funds are allocated and utilized.
  • It is based on five key indicators that measure capital expenditure efficiency and fiscal health.

2. Key Variables of the QPE Index

(a) Capital Outlay to GDP Ratio

  • Measures the share of capital expenditure (on infrastructure and asset creation) relative to GDP.
  • Higher values indicate better quality spending, as more resources are allocated to productive sectors.

(b) Revenue Expenditure to Capital Outlay Ratio

  • Compares the government’s daily operational expenses to capital spending.
  • A lower ratio suggests better fiscal discipline, as it indicates more funds are directed toward long-term development rather than short-term expenses.

(c) Development Expenditure to GDP Ratio

  • Evaluates the government’s investment in key development sectors, including education, healthcare, infrastructure, and research & development.
  • A higher ratio means greater focus on long-term economic growth.

(d) Development Expenditure as a Percentage of Total Government Expenditure

  • Indicates the proportion of government spending directed toward economic development.
  • A higher percentage signifies better quality public expenditure, prioritizing growth and welfare over administrative expenses.

(e) Interest Payments to Total Government Expenditure Ratio

  • Shows the percentage of government spending used to repay past borrowings.
  • A lower ratio reflects better fiscal management, as it reduces the burden of interest payments, freeing up funds for productive investments.

 

RBI’s Analysis of Public Expenditure Quality: Six Phases

1. Phase 1 (1991-2000): Initial Improvements with State-Level Challenges

  • At the Centre:
  • Some improvements in public expenditure quality following the 1991 economic reforms.
  • At the State Level:
  • Public expenditure quality declined due to fiscal constraints and rising revenue deficits.

2. Phase 2 (2001-2005): Deterioration Due to Rising Expenditures

  • The quality of public expenditure declined significantly for both the Centre and states.
  • Reasons:
  • Rising interest payments on past borrowings.
  • Increased revenue expenditure, reducing capital spending.

3. Phase 3 (2006-2008): Positive Impact of the FRBM Act

  • Improvements in fiscal discipline due to the implementation of the FRBM Act (2003).
  • State governments benefited from increased tax devolution, leading to better development expenditure.

4. Phase 4 (2008-2013): Global Financial Crisis & Short-term Gains

  • Government stimulus packages in response to the 2008 global financial crisis temporarily improved the QPE index.
  • However, high fiscal deficits and rising revenue expenditure weakened long-term expenditure quality.

5. Phase 5 (2014-2019): Mixed Trends in Public Expenditure Quality

  • States:
  • Improvement in public expenditure quality due to higher development spending.
  • Centre:
  • Deterioration due to challenges post-GST implementation, affecting revenue collection.

 

6. Phase 6 (2020-Present): Covid-19 Impact & Recovery Through Capex Focus

  • Covid-19 pandemic led to increased government spending on fiscal stimulus and welfare programs.
  • Despite short-term pressures, the government prioritized capital expenditure, improving the overall QPE index.

 

Key Takeaways from the RBI Analysis

1. Shift Towards Capital Expenditure Focus

  • Over time, India has recognized the importance of investing in infrastructure and development sectors.
  • The government is reducing reliance on revenue expenditure and redirecting funds toward capital projects.

2. Better Fiscal Management at the State Level

  • States have shown greater improvement in public expenditure quality compared to the Central government.
  • This is due to higher tax devolution and increased development spending.

3. Fiscal Discipline and Policy Reforms are Essential

  • The FRBM Act played a crucial role in improving fiscal discipline.
  • Ongoing policy measures and budgetary reforms are necessary to maintain long-term financial stability.

4. Impact of Economic Shocks on Public Expenditure

  • Crisis situations (e.g., 2008 financial crisis, Covid-19 pandemic) led to short-term spending increases, affecting public expenditure quality.
  • However, emphasis on capital expenditure helps in long-term economic recovery.

 

Conclusion

  • The quality of public expenditure in India is currently at its highest since the 1991 economic reforms.
  • The RBI’s QPE Index highlights improvements in fiscal discipline, capital spending, and development investments.
  • However, challenges remain, including managing fiscal deficits, reducing interest payment burdens, and ensuring efficient allocation of resources.
  • Sustained focus on capital expenditure, policy-driven fiscal discipline, and economic reforms will be key to maintaining long-term financial stability and growth.

 

Source : https://indianexpress.com/article/explained/explained-economics/explainspeaking-india-qualityof-govt-expenditure-rbi-9848686/