Union Budget & Fiscal Deficit — Set 17

Correct Answer: B. B. Using borrowed funds to finance current consumption expenditure

A Revenue Deficit means Revenue Expenditure exceeds Revenue Receipts — the government is using borrowed funds (or running down assets) for current consumption expenditure like salaries, subsidies, and interest payments. This is considered fiscally unhealthy because it means debt is being used for non-productive purposes. Persistent revenue deficits lead to debt accumulation without corresponding asset creation.

Correct Answer: B. B. Capital expenditure creates productive assets and has higher GDP multiplier effects

Capital expenditure (on roads, ports, railways, hospitals, schools) creates productive physical and social infrastructure with long-term economic returns and high GDP multiplier effects. In contrast, revenue expenditure on salaries and subsidies is consumed immediately without creating assets. Shifting the composition of government spending from revenue to capital expenditure is a key goal of fiscal quality improvement.

Correct Answer: C. C. Construction of national highways

Construction of national highways is Capital Expenditure because it creates a durable physical asset (infrastructure) that provides economic benefits for many years. Salaries, subsidies, and interest payments are all Revenue Expenditure — they are recurring, do not create assets, and are consumed within the financial year. Capital expenditure builds the nation's productive capacity.

Correct Answer: C. C. Dividends received from public sector undertakings

Dividends received from Public Sector Undertakings (PSUs) are classified as Non-Tax Revenue under Revenue Receipts because they are regular income from government investments without reducing any asset. Disinvestment proceeds reduce equity holdings (capital receipt), recovery of loans reduces receivables (capital receipt), and issue of securities creates borrowing obligations (capital receipt).

Correct Answer: B. B. Borrowing from domestic markets through government securities

India's fiscal deficit is primarily financed by borrowing from domestic markets through the issuance of Government Securities (G-Secs), Treasury Bills, and other instruments. The government also borrows externally and from small savings. Direct monetization (RBI printing money) was largely stopped in 1997 through the discontinuation of automatic issuance of ad hoc Treasury Bills. Market borrowings maintain fiscal discipline.

Correct Answer: B. B. The central bank purchasing government securities, effectively financing deficit by money creation

Debt Monetization occurs when the central bank (RBI) directly purchases government securities, effectively financing the fiscal deficit through money creation. While this provides immediate funds to the government, excessive monetization leads to inflation. India had automatic monetization through 'ad hoc Treasury Bills' until 1994, which was phased out by 1997. Currently, RBI can purchase G-Secs only in secondary markets (Open Market Operations), not directly from the government.

Correct Answer: B. B. Higher government borrowings leading to higher interest rates and reducing private investment

The Crowding Out Effect occurs when increased government borrowing to finance fiscal deficit pushes up interest rates in the economy, making credit more expensive for private firms and households. This reduces private investment, partially or fully offsetting the expansionary impact of the fiscal stimulus. High fiscal deficits sustained over time are therefore linked to lower private investment and potentially lower growth in the long run.

Correct Answer: B. B. Tax cuts financed by debt have no real effect as consumers save for future tax increases

Ricardian Equivalence, associated with economist Robert Barro, argues that when the government runs a deficit financed by debt, rational consumers anticipate higher future taxes to repay the debt and therefore save the current tax cut rather than spend it. This saving exactly offsets the government's deficit spending, meaning fiscal stimulus has no real effect on demand. Critics argue this assumes perfect foresight and capital markets, which are unrealistic.

Correct Answer: B. B. Policies aimed at reducing government fiscal deficit and debt-to-GDP ratio

Fiscal Consolidation refers to policies and measures taken to reduce the government's budget deficit and stabilize/reduce the public debt-to-GDP ratio. These include expenditure rationalization (reducing wasteful subsidies), revenue augmentation (broadening the tax base), and structural reforms (improving the quality of spending). India's FRBM Act framework is designed to institutionalize fiscal consolidation.

Correct Answer: B. B. Deliberate increase in government expenditure and/or reduction in taxes to boost aggregate demand during slowdown

Fiscal Stimulus involves deliberate expansionary fiscal policy — increasing government spending on infrastructure, welfare, and public works and/or reducing taxes — to boost aggregate demand during an economic slowdown or recession. India provided a major fiscal stimulus in 2008-09 in response to the global financial crisis, which included tax cuts, increased government spending, and measures to boost credit flow. Fiscal stimulus temporarily widens the deficit.