Context: Recently, the Reserve Bank of India (RBI) has released the ‘Quality of Public Expenditure’ Index to assess how well the government is spending public money. The latest report makes for a positive picture.
Relevance of the Topic: Prelims: Quality of Public Expenditure Index; Public Expenditure- Trends & Analysis.
Quality of Public Expenditure (QPE) Index
- Developed by the RBI to assess how well the government is spending public money.
The Index uses five variables to assess quality of spending:
- Capital outlay to GDP ratio
- Capital outlay to GDP ratio
- Development expenditure to GDP ratio
- Development expenditure measured as a percentage of a government’s total expenditure
- Interest payments to total government expenditure ratio
Variables of Quality of Public Expenditure (QPE) Index
- Capital outlay to GDP ratio:
- Money set aside by the government towards building physical infrastructure expressed as a percentage of Gross Domestic Product (GDP).
- The higher the ratio, the better is the quality of public expenditure (stronger commitment to enhance a nation's productive capacity).
- Revenue expenditure to Capital outlay ratio:
- Relative weight of the revenue & capital expenditures. Compares day-to-day operational expenses of the government (like salaries, subsidies, pensions) to the long-term capital investment.
- The lower the value of this ratio, the better is the quality of public expenditure.
- Development expenditure to GDP ratio:
- Development expenditure refers to all public expenditure to enhance production factors (labour and capital) or by improving their productivity, in order to stimulate economic growth.
- It includes expenditure on:
- Education and training
- Public infrastructure investments
- R&D (which drives technological advancement and innovation)
- Healthcare (which boosts both the size and productivity of the labour force by extending the span of healthy life).
- Subsidies (particularly those aimed at improving nutrition, such as food subsidies) to bring long-term welfare gains.
- Development expenditure as a percentage of a government’s total expenditure: The higher the value of this ratio, the better is the quality of public expenditure.
- Interest payments to total government expenditure ratio:
- Proportion of government spending on servicing debt.
- A lower value of this ratio shows better quality of public spending.
Quality of India’s Public Expenditure: Analysis by RBI
- The RBI has broken the whole period (from 1991 to now) in six phases to illustrate how structural forces have shaped the quality of public expenditure at both levels of government (Centre & states).
- Phase 1: Early Post-Liberalisation Reforms & Fiscal Realignments (1991-95):
- Centre’s index (Chart 1) showed a slight improvement in quality of public expenditure (QPE), while the States’ index (Chart 2) declined modestly. These movements were driven by the fiscal pressures faced by both levels of government.
- Public investment fell as fiscal consolidation took precedence.
- Phase 2: Pre- FRBM Consolidation (1996-2003):
- Both indices experienced a sharp decline reflecting the combined impact of the Fifth Pay Commission implementation, rising interest payments, and the persistent dominance of revenue expenditure over capital outlay.
- Phase 3: FRBM Implementation & Growth Upswing (2003-2008):
- Reflects positive effects of both fiscal discipline (as FRBM Act started guiding government borrowing) and fast economic growth making more money available for spending.
- States also benefited from higher fiscal devolution.
- The index rebounded sharply until the world was hit by the Global Financial Crisis (GFC) of 2008.
- Phase 4: Global Financial Crisis & Countercyclical Adjustments (2008-13):
- GFC prompted the Centre to adopt countercyclical fiscal measures, including stimulus packages.
- Governments, especially the Centre had to spend more in order to counter the slowdown and hurt caused by the GFC.
- While this continued to push up the index during this phase, higher spending levels resulted in higher deficits, and it eventually started eroding the quality of public expenditure.
- Phase 5: Structural Reforms & GST Rollout (2013-20):
- The trajectory of the index goes in opposite directions for the Centre and the states.
- The QPE saw an improvement in states with improvements in development spending, as well as more money being available to them, thanks to the recommendations of the 14th Finance Commission.
- The Centre further faced challenges with GST revenue sharing initially favouring the states.
- Phase 6: Pandemic shock & Infrastructure-focused recovery (2020-Present):
- Economic recovery especially driven by the heightened focus on capital expenditure helped push up the quality of public expenditure.
Thus, according to RBI’s index, the quality of public expenditure in India (both at Centre and state levels) is close to the highest point it has ever been since the start of economic liberalisation in 1991.
Recent Trend shifts in India’s Public Expenditure
- Push for Fiscal Discipline:
- To limit the tendency in government to overspend, India instituted the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.
- FRBM limit on Fiscal & Revenue Deficit:
- As per FRBM Act, the fiscal deficit should ideally not exceed 3% of GDP.
- The revenue deficit should be zero.
- Purpose: Government should only borrow for capital expenditure (and not for paying higher salaries and other similar everyday spending).
- Targeting overall debt: India has now shifted to targeting overall debt as a percentage of GDP, instead of an individual year’s fiscal deficit, as a way to maintain fiscal discipline.
- Push for higher capital expenditure: Capex boosts productive capacity of the economy.
Also Read: Re-evaluating FRBM Act 2003
India needs to enhance the Quality of Public Expenditure by continued investment in infrastructure, renewable energy, and digital transformation, keeping borrowing under control, strengthening Centre-state financial coordination and using data-driven governance models to track expenditure efficiency.