Effective Revenue deficit is a new term introduced in the Union Budget 2011-12. While revenue deficit is the difference between revenue receipts and revenue expenditure, the present accounting system includes all grants from the Union Government to the state governments/Union territories/other bodies as revenue expenditure, even if they are used to create assets. Such assets created by the sub-national governments/bodies are owned by them and not by the Union Government. Nevertheless they do result in the creation of durable assets.
According to the Finance Ministry, such revenue expenditures contribute to the growth in the economy and therefore, should not be treated as unproductive in nature. In the Union Budget (2011-12) a new methodology has been introduced to capture the ‘effective revenue deficit’, which excludes those revenue expenditures (or transfers) in the form of grants for creation of capital assets. If this methodology is taken into account, the effective revenue deficit (revised estimates) for 2010-11 is only 2.3 per cent as against the revenue deficit of 3.4 per cent of GDP. The effective revenue deficit for 2011-12 is projected at 1.8 per cent as against the revenue deficit estimates of 3.4 per cent.
It may be noted that even though some grants may be allocated towards the creation of assets, financial allocation does not always result in physical outcomes.
Grants for creation of capital assets, as a concept, was introduced in the FRBM Act through the amendment in 2012. The Act defines grants for creation of capital assets as grants-in-aid given by the Central Government to state governments, autonomous bodies, local bodies and other scheme implementing agencies for creation of capital assets which are owned by these entities.
In short, Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets. Effective Revenue Deficit signifies that amount of capital receipts that are being used for actual consumption expenditure of the Government.
Effective revenue deficit has now become a new fiscal parameter and same is targeted to be eliminated by the 31st of March 2015 and keep it at that level in the future, as per the Amendments made in 2012 to Fiscal Responsibility and Budget Management Act.
However, the 14th Finance Commission observed that the concept of effective revenue deficit is not recognised in the standard government accounting process.Under the Constitution, there are only two categories of expenditure- expenditure on the revenue account and other expenditure which is broadly expressed as capital expenditure. Hence, according to the Commission, the artificial carving out of the revenue account deficit into effective revenue deficit to bring out that portion of grants which is intended to create capital asset at the recipient level leads to an accounting problem and raises the moral hazard issue of creative budgeting. The Commission recommend that the Union Government should consider making an amendment to the FRBM Act to omit the definition of effective revenue deficit from 1 April 2015.