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Home / IAS Preparation / Fiscal Discipline

Fiscal Discipline - Key Issues and Overview of Monetary Discipline in India | UPSC Economy Notes

Last Updated on Sep 05, 2023
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Fiscal discipline is defined as an ideal balance between revenues and expenditures of the government and the government’s ability to maintain smooth monetary operations and long-term fiscal conditions. It serves as a model for tax devolution. Since the 11th Finance Commission, it has incentivised governments that manage their budgets intelligently. Budget surpluses are national savings, so fiscal discipline encourages long-term growth.

The Fiscal Discipline is significant for the UPSC Prelims and GS Paper 3 of the UPSC Mains curriculum. In this article, You will learn about Fiscal Discipline, its features, and its significance for the UPSC IAS exam.

Also, check out what is Fiscal Deficit here.

Fiscal discipline- Download PDF Here!

What is Fiscal Discipline?

Fiscal discipline refers to maintaining a balanced and sustainable government budget by controlling government spending, limiting borrowing, and ensuring that revenues match or exceed expenditures. It involves making difficult choices about allocating and prioritising public resources to achieve long-term economic stability and growth.

Fiscal discipline is critical for the economic health of a country. A government that practices fiscal discipline ensures that it does not accumulate excessive debt, which can lead to higher interest rates, inflation, and a decrease in investor confidence. A well-managed government budget also helps to ensure that resources are allocated efficiently and effectively, promoting economic growth and development.

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Importance of Fiscal Discipline
  • Fiscal discipline is critical for improving and maintaining economic performance, maintaining macroeconomic stability, and reducing risks.
  • Discipline is especially vital if countries, both developed and developing, are to successfully confront the difficulties of economic and financial globalization and reap the rewards. A lack of fiscal discipline generally results from an injudicious use of policy discretion.
  • The benefits of discretion may be observed in policymakers’ capacity to respond to unforeseen shocks and in elected political representatives’ ability to execute their mandates.
  • However, discretion may be abused, leading to prolonged deficits and procyclical policies, growing debt levels, and, in the long run, a loss of policy credibility.
  • The high cost of production starts hurting the investment process, and the reduction in investment causes unemployment. The economy sinks into a low-level equipoise trap.
  • Fiscal deficits often indicate various unfavourable domestic and external shocks that affect budgets directly and through their impact on the economic environment.

Learn the details on the Fiscal Drag Here.

The Challenge of Fiscal Discipline in the Indian States

While India has made progress in promoting fiscal discipline at the national level, its states face significant challenges in maintaining a balanced budget and managing their finances.

  • A drop in revenue implies that the government needs to make savings. Local independence has also raised concerns regarding accountability and control in the financial realm.
  • It is best to avoid a fiscal deficit resulting in a revenue shortfall since this indicates that at least some of the borrowed money is being used to finance current spending, which a government should avoid for the time being.
  • A sound fiscal policy is highly desired, but the size of the fiscal deficit is not always and everywhere a reliable sign of soundness — take the state of the economy as an example. Initially, the overall budget imbalance is shown by the fiscal deficit.
  • The revenue account, a current income and expenditure statement, is embedded in the government’s accounts.
  • A fiscal deficit may or may not include a revenue account shortfall, known as a “revenue deficit.”
  • The possibility of a revenue shortfall hidden within a budgetary deficit muddies the waters slightly because changes in the total or fiscal deficit tell us nothing about what is occurring with the revenue shortfall.

Fiscal Discipline in India
  • In India, the rising deficit is a matter of concern, but so are its composition and financing because both factors affect how the fiscal imbalance affects the country.
  • Rising revenue deficits in India are a big concern since they suggest that private savings would be appropriated for current government consumption, which tends to squeeze out private investment without a corresponding increase in government capital spending.
  • It is also agreed that during the 1990s, the primary deficit turned negative, indicating that either state were borrowing to pay for current expenses or that a significant percentage of the fiscal deficit was due to the cost of paying previous debt.
  • India is, in reality, a decentralized federal democracy with one billion people and 29 states that welcomes a wide range of ethnic, linguistic, and cultural diversity.
  • State and municipal governments spend more than half of all general government spending. It also has many characteristics of a highly centralized country, such as a quasi-federal constitution, a high concentration of effective taxing powers at the central level, a highly regulated financial market dominated by centrally-owned financial institutions, and significant parts of its economy that remain subject to central directives. Thus, the focus should be given to the effective implementation of Fiscal Discipline in India.
  • Much creativity has gone into addressing these seeming inconsistencies and making Indian fiscal federalism operate in practice. However, this same creativity has cost India some potential benefits of pure federalism, such as single responsibility.

Also, check out Fiscal Consolidation here.

Promoting Fiscal Discipline
  • Fiscal Discipline helps resist the short-term temptations of tax cuts or extra expenditure, which can successfully change fiscal stress.
  • Setting short-term, mid-term, and long-term financial goals, creating a budget, paying down debt, opening a high-yield savings account, cutting back on spending, establishing an emergency fund, developing sound investment strategies, and hiring a financial planner are all ways to practice financial discipline.
  • A fiscal council, regardless of nationality, is a permanent organization tasked with objectively assessing the government’s budgetary plans and predictions against macroeconomic sustainability metrics and publishing its conclusions in the public realm.
  • Such open examination is expected to keep the government on the straight, narrow road of budgetary virtue and hold it accountable for any default.

Fiscal Discipline and Debt

Fiscal discipline and debt are closely related. Fiscal discipline is maintaining a balanced and sustainable government budget by controlling government spending, limiting borrowing, and ensuring that revenues match or exceed expenditures. Debt, on the other hand, refers to the amount of money that a government owes to its creditors.

Fiscal discipline is essential to managing debt levels. If a government is not disciplined in its spending and borrowing practices, it may accumulate excessive debt, which can have negative economic consequences. For example, high debt levels can lead to higher interest rates, inflation, and a decrease in investor confidence.

The Debt-to-GDP ratio is the proportion of a country’s debt to its gross domestic product. It is a trustworthy measure of a country’s ability to repay its obligations.

Learn about the Difference between Monetary Stimulus and Fiscal Stimulus.

Fiscal Responsibility and Budget Management Act

Atal Bihari Vajpayee introduced the Fiscal Responsibility & Budget Management (FRBM) Act in India’s parliament in 2000 and passed it in 2003. It was passed to ensure intergenerational equity in fiscal management, long-run macroeconomic stability, better coordination between fiscal and monetary policy, and transparency in the government’s fiscal operations.

Also, check out India’s gross fiscal deficit here.

Conclusion

A quasi-federal constitution does give India a hierarchical authority system to support the preservation of hard budget limitations. Still, many other characteristics of the federal fiscal system, as it existed in the 1990s, allowed states to experiment with soft budgeting. Traditional fiscal disciplines mechanisms, such as capital market risk premia, electoral disfavour, capital effects, debt capitalisation and future tax burdens on privately owned asset values, have yet to give substantial impetus.

In this article, we analyzed the structure and terms of fiscal discipline in India. You can check out our UPSC Online Coaching, and download the Testbook App now to check out various other topics relevant to the UPSC IAS Exam.

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Fiscal Discipline FAQs

Fiscal discipline is defined as a balance between government expenditure and revenue in an economy. It is critical to maintain this equilibrium, or else government spending will surpass government income.

Failure to maintain fiscal discipline might result in currency depreciation and economic inflation. It will contribute to the economy's overall stability.

Fiscal policies are classified into three types: Neutral Policy, Expansionary Policy, and Contractionary Policy

A fiscal deficit occurs when the government's expenditure exceeds its revenue in a given year.

Fiscal responsibility in government institutions refers to the capacity to balance government expenditure and taxation.
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