Wednesday, August 29, 2012

Financial Administration: Monetary and fiscal policies; Public borrowings and public debt; Budgets - types and forms; Budgetary process; Financial accountability; Accounts and audit.

Today we are to talk about Financial Administration which is the fuel for all Administrative activities. As Kautilya said famously in his renowned book ' Arthashastra' that all undertakings depend on finance and so foremost attention should be paid to the treasury. Therefore, one can very well understand the immense value attached to this aspect of Public Administration.

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Let us begin.

As per the definition given by the USA Census department, Financial Administration involves all the activities of finance and taxation. Includes central agencies for accounting, auditing, and budgeting; the supervision of local government finances; tax administration; collection, custody, and disbursement of funds; administration of employee-retirement systems; debt and investment administration; and the like.
So,in simple words Financial Administration is an all encompassing term for all those functions /operations having the objective to make funds and finance available to the government for its duties and responsibilities to be carried out smoothly and also all those activities that ensure the lawful and efficient use of those funds/finance.
And these functions are collectively performed by the Executive(asks for funds),Legislature(that has the sole power to grant those funds),Finance Ministry(controls those funds) and the Auditor(to audit whether the funds were used for what they were demanded).
The steps involved are preparation of the budget for the ensuing financial year,getting it passed by the legislature,executing the budget and collecting the funds for it,managing those funds via the treasury and the audit of the Centre and State executive accounts by the Audit authority.

So one can understand the importance of Financial Administration in its element. A balanced and precise financial administration is the base as well as the means to attain successfully all goals of development as well as growth of a country.

Monetary Policy is the process by which monetary authority(an authority that controls all matters relating to money) of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability,reduce inflation and achieve high economic growth. A sound monetary policy ensures that various sectors of the economy have sufficient tokens/authority to carry out their transactions. It provides the basis to the fiscal policy and the fiscal policy influences the monetary policy and gives it a direction to proceed in. Monetary policy helps in keeping the money supply and economy of a nation stable whereas the fiscal policy is more involved in development and infrastructural work and policy making and enactment of budget. A monetary policy is changed from time to time to combat inflation,deflation,price rise,imbalance in demand and supply,etc by mopping up excess money or infusing money in the market as the requirement may be. A sound monetary policy helps the government determine its fiscal policy and how much it will collect as revenue and spend as expenditure. The fiscal policy helps bring money into the market whereas the monetary policy helps in managing that money supply and keeping it stable. In India the monetary policy is managed by the RBI which is the central bank as well as monetary authority of the country.

The major operations/techniques of the RBI to implement its monetary policy for furthering the goals of economic growth are:
1) Supply of money/money supply : Printing currency or facilitating foreign inflow of the same.
2) Interest rates : By rising it or dropping it the bank controls money supply in the market.
3) Open Market Operation: Buying and selling of government bonds/securities from or to the public and banks as and when it wants to mop up excess money supply in the market or infuse money supply into the market.
4) Cash Reserve ratio: It is a certain percentage of bank deposits that a bank needs to keep reserve with the RBI. A high CRR is when the RBI wants to mop up excess liquidity in the market and a lower CRR is when the RBI wants to infuse liquidity into the market.
5) Statutory Liquidity ratio: Every financial institute needs to maintain a certain amount of liquid assets in the form of cash,precious metals,bonds,etc from their time and demand liabilities with the RBI. A high SLR is to mop up excess liquidity in the market and a lower SLR is the opposite.
6) Bank Rate Policy: Also known as discount policy. It is is the rate of interest charged by the RBI for providing funds or loans to the banking system.
7) Credit ceiling: RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit.This is done when the priority sectors need assistance support is given to limited sectors. It saves up funds for priority sector funding of government.
8) Credit Authorization scheme: RBI as per the guidelines of this scheme authorises banks to advance loans to desired sectors.
9) Moral suasion: RBI requests banks not to indulge in loan giving to unproductive sectors and maintain discretion so that the economy benefits.
10) Repo Rate and Reverse Repo Rate: Repo rate is the rate at which RBI lends to commercial banks against government bonds and securities and Reverse Repo is the opposite of the former. An increase in repo rate means that the banks have to pay more interest on loans taken from the RBI and thus excess liquidity is mopped up and a decrease in the repo rate means more money at a cheaper rate of interest to the banks. An increase in reverse repo infuses liquidity into the banks for the RBI pays a higher interest to the banks upon borrowing loans from them and a decrease in reverse repo rate ensures the opposite of the former.

It is the policy taken out by the government regarding the use of revenue (taxation) and expenditure among various sectors to influence the country's economy and achieve welfare objectives like economic growth and development full employment,price stability and balanced demand and supply system within and outside. The fiscal policy is a statement of the same. And the most visible tool of the fiscal policy in action is the 'Budget'. Monetary policy and Fiscal Policy are complementary and equally necessary in managing a nation's economy as is already explained above under Monetary Policy.

There are three possible ways of Fiscal policy in the Public domain-
1) Neutral Fiscal policy - It implies a policy for a balanced budget where government spending is equal to the revenue/tax collected and so there is status quo in the economy.
2) Expansionary Fiscal Policy - Where govt. spending exceeds taxation revenue leading to a larger budget deficit.
3) Contractionary fiscal policy - Where govt. spending is less then what is collected as revenue. It is usually associated with a budget surplus remaining with the govt.

When there is a deficit in the budget that means expenditure is more than income/revenue for the government then the government resorts to borrowing from the Public in the form of government issued treasury bills, post office savings certificates, National Saving Certificates,Provident Fund,Fixed deposits,etc as instrument of Public borrowings for the time period that the person takes it for and that is why we see attractive advertisements taken out from time through Public as well as private sector banks and institutions with good rates of interest to attract investors to invest with them, and all this is paid by the government through its fiscal policy in order to garner more funds year after year for their development activities and economic growth.Public borrowing also helps in curbing inflation and seize away the excessive and unnecessary purchasing power from the public during an inflationary period.However,when even that is exhausted to an extent then the government borrows from the Reserve Bank Of India when it wants to meet the remaining part of deficit in the budget and thus it is also known as deficit financing. Deficit financing helps the government meet their resource crunch expeditiously and also the interest that the government pays back to the RBI upon returning those borrowings actually come back to them in the form of profits so it is a beneficial tool for the government. However,deficit financing involves printing of new currency through RBI to give to the government and that leads to infusion of excess money supply into the market through government activities leading to money getting concentrated in the hands of a few who can afford and thus consumption increases leading to less supply and so prices rise which in short is inflation. Therefore deficit financing leads to inflation.

The money and interest/debt that the government has to pay back to the Public when it borrowed from it(please look above for the instruments used in Public Borrowing)  is known as Public debt. It has been on a constant rise in developing countries since a long time due to haphazard budgets and unforeseen circumstances that lead to a not so proper implementation of even a proper budget. Public debt can be both internal as well as external. Internal has been discussed above. External debt is when the government of a country borrows from global institutions like the World Bank and International Monetary Fund,etc.

1) Reproductive and Unreproductive debt - Reproductive debt is when money is borrowed to invest in an infrastructural project like railways,irrigation,etc which when finished will be used by the public and provide revenue through taxes and be profitable for the government. On the other hand unreproductive debt refers to those borrowings that are done for meeting expenditures like war,etc which will not yield any direct revenue upon completion.

2) Voluntary and compulsory debt - Voluntary debt is when the public is free to decide whether they want to provide loans to the government or not and compulsory is when the public is legally compelled to provide funds like in 1971 the ' Compulsory deposit scheme' was introduced.

3) Internal and External debt - It has already been detailed above.

4) Long term and short term debt - Long term debt is when the debt has to be repaid after a year and short term debt is when it has to be repaid within a year.

Budget is an estimate of income and expenditure for a set period of time in India's case it is of a year. It is the detailed implementation plan of the fiscal policy of the State in hard figures and facts and activities to be pursued for executing and implementing the same for socio-economic development of a country by the executive. It is defined as a series of goals with price tags attached. Where a line item is detailed and a price/cost is mentioned next to it.

1) As a tool of financial control of the legislature over the executive.
2) As a tool of administration for carrying out its functions as per specified and approved budget.
3) An instrument of Public Policy for development and welfare as well as economic and social growth and development.
4) As a tool of accountability for the legislature over the executive.
5) Budget helps getting five year plans into action.

1) Short term - annual - long term Budget : If a Budgetary proposal happens to be for less than a year then it is considered to be a short term budget. Proposal for a year is classified as an Annual Budget and proposals for more than a year are classified as long term budgets.

2) Surplus - Balanced - Deficit : A proposal is considered to be a surplus budget if revenues in a year exceed the expenditure of the same year. A balanced budget is that where both the sides are equal. And a deficit budget is one where the expenditures for the year exceed the revenue for that year.

3) Cash Budget - Revenue Budget : That form of budget where the proposals are based on cash that means in terms of actuals and not based on accruals (increasing or projected increase). It is in practice in India,U.K and USA. Under this type of budget there is a 'rule of lapse' which means that once the validity of the budget appropriation is over,all remaining or unutilised funds will lapse and a fresh proposal will have to be put forward to the legislation for receiving further grants. This kind of budget is considered suitable because it allows re-prioritization of activities of the executive and is a more comprehensive format.
Revenue budget refers to that form of budgeting where proposals are based on accruals and appropriation for their authorization are linked to the completion of the activities and not the validity or life cycle of the budget.

4) Lumpsum Budget: It is a proposal where expenditures are not provided heading wise rather an overall estimate is presented for the approval of the legislature. It is considered useful when funds are required to be appropriated for some unspecified or unclear activity/area which is in the process of determination.

5) Line - Item Budget: It is considered as one of the most popular format as it is simple in approach as well as in understanding. It is that technique of budgeting where every item has a dedicated separate line and column for its complete description along with its rate and the total quantity required as well as the funds required for it are clearly specified. It helps in more accountability of the executive as well.
The drawback of this technique is that it fails to link expenditure with performance after such expenditure as the focus is totally on the expenditure and all the detailing goes into that. It is not comprehensive in its outlook.

6) Performance Budget: A result of the First Hoover Commission in 1949 ( refer - ) it was first applied for federal budgeting in 1950 by President Truman. It is a technique under which allocation of funds are based on functional classification. It specifies the demands with the heading as well as the objective it sets out to achieve. Thus the legislature has total control over the executive actions and knows what it is to expect at the end of the Budget life cycle and can evaluate it and hold them accountable. This type of budget shows a clear relation between inputs and outputs. It helps the legislature hold the executive accountable in a better manner,helps head of departments of administration as communication for activities is clear from top to bottom and they find it easier to direct subordinates and achieve the specified goals,it helps the auditor as well as he has a clear idea of each and every detail as mentioned above. This technique was first recommended by the Estimates Committee in 1956,however,it was introduced in Parliament for the first time in 1968-69 on recommendation of the first Administrative Reforms Commission.
The limitations to this technique are:
i) Difficult to measure performance of various activities of govt./executive for it is quite vague and cannot be directly measured.
ii) Expenditure made by govt. under number of heads do not present themselves in the form of results that are objective enough to be directly measured.
iii) For various govt. activities,it is not easy to determine the unit cost of such activities.
iv) Not easy to establish links between development heads and accounting heads.

7) Planning Programming Budgeting System (PPBS) :
This system was first developed by General Motors in 1920's for managing financial matters and then implemented in the department of defense. Impressed by the results it was first introduced into political fray for Federal budgeting in 1966 by President Johnson of USA as a replacement for the shortcomings of the Performance Budget system.
It incorporates planning function where basic goals of the organisation are determined along with the selection of programmes that are best suitable to achieve them. Programming encompasses the scheduling and execution of those programmes efficiently through clearly defined projects.Budgeting then takes over to convert the goals,programmes and projects into monetary estimates for a review of the administrative heads and then to be presented to the legislature for appropriation. This technique thus seeks to incorporate all functions of Planning,Decision Making and Budgeting of government goals and objectives/policies.
Limitations of this technique are :
i) Tries to incorporate different departments and agencies work together thus making the process cumbersome.
ii) Periodic reviews and evaluations needed to check its effectiveness along with good and clear coordination between different agencies like planning,bureaucracy,accounting/finance ministries and departments,etc.
iii) Analytical in nature and not practical.
iv) Socio economic objectives are difficult to follow in a calculated manner as a lot of variables come into play.

8) Zero Based Budgeting : This technique was developed at the Texas Instrument Company in USA by Peter Phyrr and adopted for the Federal Budget calculation in 1977 by President Carter.
It is an evaluation of all programmes and expenditures of every year requiring each manager/administrator/executive head to justify his entire budget request in detail.
Evaluation of operational activities are done in terms of costs and benefits. It is based on a comprehensive analysis of priorities,goals and objectives making it more realistic and practical. Targets are specified through efficient planning and control functions.It helps enable better communication and personnel development in organisations.
Limitations are:
i) Effective administration and communication is necessary to implement this technique.
ii) Requires a lot of investment and updated infrastructure and properly trained personnel.
iii) Large data processing and making.
iv) Human biasedness in selection of decisions cannot be overlooked.

There are two types of budget presented to the legislature for passing - General Budget and Railway Budget at the central level. They were separated in 1921 to preserve the business approach to the railway policy and after paying the annual contribution the Railway can keep their profit and keep the profit for their development.

 Once requisite data is collected from all ministries and departments and scrutinized in tandem by the controlling officers and the Accountant-General and the administrative departments,it is then reviewed by the Finance Ministry and again the same process is followed by the Union Cabinet. That is why there is collective responsibility of the cabinet for the budget in Parliament.

The budget is then framed by the Finance ministry in the proper format after consulting the Planning Commission for including the Plan priorities and the help of CAG is also taken for getting previous years data of accounts. All this work begins in September of the current year for preparation of budget for the next financial year beginning on April 1st.

The States have their own budget and the same procedure is followed but done by the State Finance Department following the same procedure as in the Centre and has to be approved by the respective State Legislature.

After compiling the budget then the Finance Minister presents the same in the Lok Sabha for the Parliament approval. Whether this much fund is actually required or not once put in front of the parliament for passing is sent to the Estimates Committee to do the scientific financial assessment of the same and report to the legislature whether funds demanded are estimated precisely or not. A general discussion then pursues in parliament over the budget document and then a voting on the demand of grants take place,it is then considered again and the Appropriation Bill is then passed for the government to incur expenses from the Consolidated Fund of India then another round of consideration takes place for the revenue/taxation proposals of the budget and after that the Finance Bill is passed authorising the govt. to collect taxes and revenue.
For more refer to -

Once the process of passing the bill is completed then the execution of the budget begins. The Finance Ministry then takes over as it has the charge of the treasury of funds. It then calls in the respective administrative ministries and departmental heads to present their plan of outcomes for the appropriated/granted funds and write the reasons for the amount to be disbursed to their departments/ministries. Once that is prepared and the scheme is presented to the Finance ministry then the ministries are provided with certain guidelines/instructions that they need to pursue in regards to their spending and the funds being disbursed to them from the treasury through the Finance Ministry. Regular check is kept on them from them on to ensure accountability.

If a Finance Bill is rejected in the House then the whole cabinet has to resign based on the principle of Collective Responsibility.

Financial Accountability or accounting refers to the system of recording and maintaining data of all financial transactions of both the Centre and State. It is a means of the legislature as well as executive to exercise financial control over funds granted. It gives the details of the financial health of the government and also provides a clear account of loss as well as profit to the exchequer and whether the funds granted by the legislature were utilised for the same purpose as demanded and whether the goal was accomplished or not.

1) Control Accounts -  It contains data of all expenditure and revenue as well as funds receipts/financial transactions of the government.
2) Proprietary Accounts - Maintained for the purpose of internal control and are not subject to external audit and is helpful for departments and ministries in decision making process.
3) Supplementary Detailed Accounts - Prepared for providing information to the general public about government functioning in terms of various department spending. It is prepared after 2-3 years of actual funding and is so formatted to be easily comprehensible for public viewing.

All accounts of the Centre as as well as States are maintained by the office of the Comptroller and Auditor General. Under the CAG there is an Accountant General appointed in each state who keeps that particular state's records in his office and then it is passed on to the CAG at the time of auditing.
Railway accounts are maintained separately under the Financial Commissioner of Railways and the Defence accounts are maintained by the Finance ministry through the Financial Adviser ( Defense) and Military Accountant-General.

1) Initial Entry : It takes place in the administrative office where the actual spending takes place. It is done in real time.
2) Monthly compilation in the office of the Accountant General (AG): Every month all the details of financial transactions done through initial entry step of the respective administrative office is forwarded to the AG office where it is classified properly and maintained under specific account heads like capital expenditure,revenue expenditure,revenue receipts,etc.
3) Annual compilation in office of AG: Annual compilation of all monthly reports sent by respective administrative offices are classified and maintained in AG office.
4) Final compilation in the office of the CAG.

Audit is a Union subject and it refers to the systematic examination of accounts carried out for the objective of verifying validity of the financial transactions carried about by the administrative depts under the executive to determine the correctness of its process as specified in the budget approved by the legislature.
The audit function is performed by the CAG which is an autonomous constitutional body under the govt. of India act 1935 and is appointed by the President under his warrant and seal. Indian Audit is governed by not by legislature/law but by an executive order - The Government Of Indian Audit and Accounts Order 1936.
At presents receipts of Income tax collected are not open to audit by the CAG,rest all are.
Once the CAG compiles the Audit reports it then presents it to the President and the Governor of respective States to be presented before the Parliament and State legislatures via the two respectively.
Once that is received by the legislature it is then sent for another audit and review to the Standing committee called Parliamentary Accounts Committee consisting of both the houses representatives,the same committee is present in each state legislature and performs the same function.Once that is done then its recommendations and findings are then presented back to the House for debate and suitable action to be taken.

This article ends here.

IGNOU notes -

And,the series of posts/articles covering the complete study of Administrative Theory completes here.


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The next post on this blog will be the first in the series of articles that sets out to cover the study of INDIAN ADMINISTRATION. 

So, the next article will be detailing:

Evolution of Indian Administration:
Kautilya’s Arthashastra; Mughal administration;
Legacy of British rule in politics and
administration - Indianization of public services,
revenue administration, district administration,
local self-government.


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