Fiscal Policy in India Since 1991: Budget, Deficits, FRBM and GST for RBI Grade B ESI
Last updated: 2026-11-11 · MockMentor
Fiscal policy is the other half of "Monetary and Fiscal Policy since economic reforms of 1991" in the Indian Economy unit of the RBI Grade B Phase 2 Economic and Social Issues (ESI) syllabus. Every year the Union Budget, the Economic Survey and the Finance Commission give examiners fresh material, and questions on deficits, debt, GST and fiscal federalism appear almost every year in descriptive papers. This chapter covers the budget and its functions, the structure of receipts and spending, the measures of deficit, public debt, the FRBM framework, GST and how fiscal policy has changed since 1991.
In one line: fiscal policy is the government's use of taxes, spending and borrowing to steer the economy, and since 1991 India's central challenge has been to fund growth and welfare while bringing down deficits and debt.
Basic concepts
- Fiscal policy: the use of government revenue (taxes and other receipts), expenditure and borrowing to influence the level of economic activity, the distribution of income and the allocation of resources.
- Budget: the annual financial statement of the government's estimated receipts and expenditure for a financial year (1 April to 31 March). Article 112 of the Constitution calls it the Annual Financial Statement.
- Fiscal deficit: the gap between the government's total expenditure and its total receipts other than borrowings. It equals the amount the government must borrow in a year.
- Public debt: the total of the government's outstanding borrowings, from within the country and from abroad.
- Fiscal consolidation: steady reduction of deficits and debt as a share of GDP.
- Counter-cyclical fiscal policy: spending more or taxing less in a slowdown, and the reverse in a boom, to smooth the business cycle.
- Fiscal federalism: the division of taxing powers, spending responsibilities and transfers between the Centre, states and local governments.
Why in News?
- The Union Budget 2026-27, presented on 1 February 2026, set the fiscal deficit target at 4.3% of GDP, down from 4.4% in 2025-26, with capital expenditure of ₹12.2 lakh crore and gross tax revenue of ₹44.04 lakh crore. Total expenditure is about ₹53.47 lakh crore.
- The government has moved from an annual deficit target to a debt anchor: it aims to bring the Centre's debt to 50% (plus or minus 1%) of GDP by 2030-31, from 55.6% estimated for 2026-27.
- The Sixteenth Finance Commission, chaired by Arvind Panagariya, tabled its report on 1 February 2026. It kept the states' share in the divisible pool of central taxes at 41% for 2026-27 to 2030-31, added "contribution to GDP" as a criterion for sharing among states, and recommended a fiscal deficit limit of 3.5% of GDP for the Centre by 2030-31 and 3% of GSDP for states.
The government budget
Objectives of the budget
Richard Musgrave described three functions of public finance, which remain the standard framework:
| Function | What it means | Examples in India |
|---|---|---|
| Allocation | Providing public goods and correcting market failures, which markets alone would under-supply | Defence, roads, police, research, public health |
| Distribution | Reducing inequality of income and wealth through taxes and transfers | Progressive income tax, food subsidy, rural employment, pensions |
| Stabilisation | Smoothing fluctuations in output, employment and prices | Higher spending in the 2008 and 2020 downturns; consolidation in good years |
Other objectives in India include economic growth through public investment, reducing regional disparities, and managing public enterprises.
Constitutional provisions
| Article | Provision |
|---|---|
| 112 | The President causes the Annual Financial Statement (the budget) to be laid before both Houses |
| 110 | Definition of a Money Bill; only the Lok Sabha can pass it finally |
| 113 to 114 | Demands for grants voted by the Lok Sabha; the Appropriation Bill authorises withdrawal from the Consolidated Fund |
| 265 | No tax can be levied or collected except by authority of law |
| 266 | Consolidated Fund of India (all revenues, loans raised and loan repayments received) and the Public Account (money held in trust, such as provident fund and small savings) |
| 267 | Contingency Fund of India, at the disposal of the President for unforeseen expenses |
| 270 | Sharing of central taxes with states |
| 275 and 282 | Grants to states |
| 280 | Finance Commission, appointed every five years |
| 279A | GST Council |
| 292 and 293 | Borrowing by the Union (on the security of the Consolidated Fund, within limits set by Parliament) and by states (states need the Centre's consent to borrow if they owe it money) |
Components of the budget
Receipts
| Revenue receipts (do not create liabilities or reduce assets) | Capital receipts (create liabilities or reduce assets) |
|---|---|
| Tax revenue: direct taxes (income tax, corporate tax) and indirect taxes (GST, customs, excise duty on petroleum) | Borrowings: market loans, Treasury bills, small savings, external loans |
| Non-tax revenue: interest receipts, dividends and profits from public enterprises and RBI, fees, fines, spectrum charges | Recovery of loans given earlier |
| Grants received | Disinvestment proceeds and other non-debt receipts |
Expenditure
| Revenue expenditure (does not create assets) | Capital expenditure (creates assets or reduces liabilities) |
|---|---|
| Salaries, pensions, interest payments, subsidies, grants to states for running costs, defence revenue spending | Building roads, railways, ports, defence equipment; loans to states and public enterprises; repayment of loans |
Interest payments are the largest single item of the Centre's revenue expenditure, taking up a large share of its net revenue. That is why reducing debt matters: it frees money for development.
Earlier, spending was also classified as plan and non-plan. This was dropped from 2017-18, when the Planning Commission no longer existed and the budget was presented on 1 February instead of the last working day of February. The Railway Budget was also merged with the Union Budget in 2017.
Effective capital expenditure
Some grants to states and union territories are used to create capital assets, such as roads under the Pradhan Mantri Gram Sadak Yojana. These are counted as revenue expenditure in the Centre's accounts. Adding them to capital spending gives "effective capital expenditure", a better measure of the government's investment.
Types of budget balance
| Type | Meaning | Effect |
|---|---|---|
| Balanced budget | Expected receipts equal expected expenditure | Neutral in principle; may be too rigid in a downturn |
| Surplus budget | Receipts are more than expenditure | Reduces demand; useful when inflation is high |
| Deficit budget | Expenditure is more than receipts | Raises demand; used to fund development and in downturns |
Keynes argued that in a recession, a deficit budget is the right response, because private demand is weak. Most developing countries, including India, run deficit budgets because their development needs exceed what taxes can fund.
Measures of deficit
| Measure | Formula | What it shows |
|---|---|---|
| Revenue deficit | Revenue expenditure minus revenue receipts | The government borrowing to meet day-to-day expenses, which does not create assets |
| Effective revenue deficit | Revenue deficit minus grants for creating capital assets | Revenue deficit after allowing for grants that build assets; introduced in 2011-12 |
| Fiscal deficit | Total expenditure minus (revenue receipts plus non-debt capital receipts) | The total borrowing need of the government |
| Primary deficit | Fiscal deficit minus interest payments | Borrowing needed for current needs, excluding past debt; shows whether the debt problem is getting worse |
| Monetised deficit | The part of the fiscal deficit financed by RBI buying government securities | The direct addition to money supply from deficit financing |
For 2026-27, the Centre's fiscal deficit is budgeted at 4.3% of GDP and the revenue deficit at 1.5%. The fiscal deficit was 9.2% of GDP in 2020-21, the pandemic year, and has been brought down every year since.
Deficit financing
When a government spends more than it earns, it can fund the gap by:
- Borrowing from the public and banks in the market, which may push up interest rates and "crowd out" private investment.
- Borrowing from abroad, which adds to external risk.
- Borrowing from the central bank (printing money), which risks inflation.
Before 1997, the Centre automatically financed its deficit by issuing ad hoc Treasury bills to RBI. That practice was ended by an agreement in 1994, and the FRBM Act later barred RBI from subscribing to primary issues of government securities, except in special circumstances.
Public debt in India
Public debt has three main parts: internal debt (market loans, Treasury bills, cash management bills and securities issued to banks and others), external debt (loans from multilateral bodies such as the World Bank and from foreign governments), and other liabilities in the Public Account (small savings, provident funds, reserve funds).
| Measure | Level |
|---|---|
| Central government debt (2026-27, budget estimate) | 55.6% of GDP |
| Target for central debt by 2030-31 | 50% plus or minus 1% of GDP |
| Combined Centre and states debt (2026-27, projected by the Sixteenth Finance Commission) | 77.3% of GDP |
India's debt is high for an emerging economy, but it carries lower risks than the headline suggests: almost all of it is in rupees, owed to domestic lenders, with long average maturity. The main cost is high interest payments, which crowd out spending on health, education and infrastructure.
The FRBM framework
The Fiscal Responsibility and Budget Management Act, 2003
Based on the recommendations of the E.A.S. Sarma Committee (2000), the FRBM Act was passed in 2003 and came into force in July 2004. Its main provisions were:
- Eliminate the revenue deficit and cut the fiscal deficit to 3% of GDP by 2008-09.
- Limit government guarantees and additional liabilities.
- Prohibit borrowing from RBI except through Ways and Means Advances (temporary advances to cover gaps in cash flow).
- Require the government to place three statements with the budget: a Medium-Term Fiscal Policy Statement, a Fiscal Policy Strategy Statement and a Macroeconomic Framework Statement.
Most states passed their own fiscal responsibility laws, encouraged by debt relief from the Twelfth Finance Commission.
Changes and the debt anchor
The targets were suspended after the global financial crisis of 2008. In 2012, the Act was amended to add the effective revenue deficit and a Medium-Term Expenditure Framework Statement. The N.K. Singh Committee (2017) recommended using debt as the main anchor: general government debt of 60% of GDP (40% for the Centre and 20% for states) by 2023, with fiscal deficit as the operating target. The 2018 amendment adopted these debt targets, along with an "escape clause" allowing the deficit to exceed the target by up to 0.5% of GDP in events such as war, national calamity or a sharp fall in growth.
The pandemic pushed debt far above these targets. The government's current path, set out in the Budget 2025-26, is to reduce the Centre's debt to about 50% of GDP by 2030-31, and the Sixteenth Finance Commission has recommended a fiscal deficit of 3.5% for the Centre by then.
Fiscal policy since 1991
| Phase | What happened |
|---|---|
| 1991 to 1997: crisis and correction | The fiscal deficit was cut from about 7.6% of GDP in 1990-91 to under 5%. Tax rates were cut and the base widened on the Chelliah Committee's advice. Ad hoc Treasury bills were phased out. |
| 1997 to 2003: slippage | The Fifth Pay Commission, slower growth and lower tax buoyancy pushed the combined deficit of the Centre and states close to 10% of GDP. |
| 2003 to 2008: rules-based consolidation | The FRBM Act; strong growth and buoyant taxes brought the Centre's deficit down to 2.5% of GDP in 2007-08. |
| 2008 to 2014: stimulus and pressure | Tax cuts and higher spending after the global financial crisis; the deficit rose to 6.5% in 2009-10, and high deficits fed inflation and the 2013 rupee crisis. |
| 2014 to 2020: consolidation and reform | GST (2017), the corporate tax cut (2019), direct benefit transfers and a gradual fall in the deficit to around 3.5%. |
| 2020 to 2021: pandemic | A fiscal deficit of 9.2% of GDP, with free food grains, credit guarantees and higher capital spending. |
| 2021 onwards: quality of spending | Steady consolidation with a sharp rise in capital expenditure, more transparent budgeting (bringing off-budget borrowings such as Food Corporation of India loans onto the budget), and a shift to a debt anchor. |
The most notable change after 2020 has been in the quality of spending. The Centre's capital expenditure rose from about 1.6% of GDP before the pandemic to over 3%, while subsidies and revenue spending were controlled.
Fiscal federalism and the Finance Commission
The Constitution gives the Centre the more buoyant taxes (income tax, corporate tax, customs) while states carry much of the spending on health, education, police, agriculture and local services. This "vertical fiscal imbalance" is bridged by transfers. The Finance Commission, set up every five years under Article 280, recommends:
- The share of states in the divisible pool of central taxes (vertical devolution).
- How this share is divided among states (horizontal devolution).
- Grants-in-aid to states and local bodies.
Sixteenth Finance Commission (2026-31)
| Criterion for sharing among states | Fifteenth FC weight | Sixteenth FC weight |
|---|---|---|
| Income distance (gap from richer states' per capita income) | 45% | 42.5% |
| Population (2011) | 15% | 17.5% |
| Demographic performance | 12.5% | 10% |
| Area | 15% | 10% |
| Forest and ecology | 10% | 10% |
| Tax and fiscal effort | 2.5% | Dropped |
| Contribution to GDP | Not used | 10% |
It also recommended grants of about ₹9.47 lakh crore over five years, mostly to rural and urban local bodies and for disaster management, and the end of revenue deficit grants and off-budget borrowings.
A recurring debate is that cesses and surcharges, which the Centre does not share with states, have grown as a share of its gross tax revenue, shrinking the divisible pool. States also argue that criteria based on income distance penalise states that have grown faster.
Goods and Services Tax
What GST is
GST, introduced on 1 July 2017 through the 101st Constitutional Amendment Act, 2016, is a destination-based tax on the supply of goods and services. It replaced central taxes (central excise, service tax, additional customs duties) and state taxes (VAT, entry tax, entertainment tax, luxury tax and others). It is often summed up as "One Nation, One Tax, One Market".
Structure
| Component | Levied by | Applies to |
|---|---|---|
| Central GST (CGST) | Centre | Supply within a state, along with SGST |
| State GST (SGST) or Union Territory GST (UTGST) | State or union territory | Supply within a state, along with CGST |
| Integrated GST (IGST) | Centre, later shared with the destination state | Supply between states, and imports |
Alcohol for human consumption is outside GST. Petroleum crude, diesel, petrol, natural gas and aviation turbine fuel are within GST law but will be taxed only from a date the GST Council recommends; till then, central excise and state VAT apply.
Input tax credit
A business pays GST on what it buys and collects GST on what it sells. It can deduct the tax paid on inputs from the tax it owes on its output. This avoids "tax on tax" (cascading), which was a major flaw of the earlier system, and it encourages businesses to buy from registered suppliers, which widens the tax net.
The GST Council
Under Article 279A, the GST Council is chaired by the Union Finance Minister, with the Union Minister of State for Finance and the finance ministers of all states as members. Decisions need a three-fourths majority of weighted votes: the Centre has one-third of the votes and all states together two-thirds. It recommends tax rates, exemptions, thresholds and rules. In 2022, the Supreme Court held that the Council's recommendations are persuasive, not binding.
GST 2.0
From 22 September 2025, the GST Council moved from four main slabs (5%, 12%, 18% and 28%) to two main slabs of 5% and 18%, with a special rate of 40% for a few luxury and harmful goods. Many items of mass consumption moved to 5% or nil. The compensation cess, which funded payments to states for revenue losses in the first years of GST, is being phased out. Gross GST collections were ₹22.27 lakh crore in 2025-26.
Benefits and issues
GST has created a common national market, cut checkpoints and transport time, widened the tax base and improved compliance through invoice matching. The problems have included frequent changes in rates and rules, high compliance costs for small firms, refund delays, fake invoices to claim input credit, and disputes between the Centre and states over compensation and revenue.
Types of budgeting
| Type | Meaning |
|---|---|
| Zero-base budgeting | Every item of spending must be justified afresh each year, as if starting from zero, instead of adding to last year's allocation |
| Performance budgeting | Links spending to the activities and programmes it funds, showing what each department does with its money |
| Outcome budgeting | Links spending to measurable outcomes (such as children immunised or kilometres of road built), introduced in India in 2005 |
| Gender budgeting | Shows how much of the budget goes to programmes that benefit women; the Gender Budget Statement has been part of the Union Budget since 2005-06 |
| Green budgeting | Tracks the environmental impact of spending and tax policy |
Challenges of fiscal policy in India
- High combined debt and interest payments of the Centre and states.
- A low tax-to-GDP ratio for India's income level, with a narrow income tax base.
- Rising spending on subsidies, pensions and freebies in some states.
- Off-budget borrowing by public enterprises and state companies, which hides true liabilities.
- Dependence of states on transfers, and disputes over cesses and GST compensation.
- The need to fund defence, infrastructure, climate adaptation and an ageing population at the same time.
Way forward
- Keep reducing deficits along the debt path, while protecting capital expenditure.
- Widen the tax base through better use of data, simpler laws and fewer exemptions, and complete GST reform, including bringing fuels in over time.
- Improve the quality of spending: better targeting of subsidies, outcome-based budgets and independent evaluation.
- Strengthen state finances through better power sector finances, property taxes for cities and full disclosure of off-budget debt.
- Consider an independent fiscal council, as the N.K. Singh Committee recommended, to review forecasts and compliance with fiscal rules.
Possible exam and interview questions
- Explain the different measures of deficit used in India. Why is the primary deficit important for debt sustainability? (420 words)
- Trace the evolution of India's fiscal policy since 1991. Is the shift from a deficit target to a debt anchor a step forward? (620 words)
- Discuss the role of the Finance Commission in fiscal federalism, with reference to the Sixteenth Finance Commission.
- What were the main changes made under GST 2.0, and what problems of GST still need attention?
- Interview: Should the government cut capital spending to meet its fiscal deficit target in a year of slowing growth?
Related reading: monetary policy since 1991, economic reforms since 1991, and our descriptive writing guide.
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