We estimate the wisdom of nations by seeing what they did with their surplus capital.
Paul Cook, Business executive
FINANCE AND FINANCIAL SYSTEM
Finance is the provision of money at the time when it is needed. It is a system of monetary relations leading to formation, distribution and use of money in the process of its turnover between economic entities.
The financial system is the network of institutions through which firms, households and units of government get the funds they need and put surplus funds to work. Savers and borrowers are connected by financial intermediaries including banks, thrift institutions, insurance companies, pension funds, mutual funds, and finance companies.
Finance in an economic system comprises two parts: public finance and finance of economic entities.
Public finance is the study of the role of the government in the economy.
The purview of public finance is considered to be threefold governmental effects on:
(1) Efficient allocation of resources. In theory, under certain circumstances, private markets will allocate goods and services among individuals efficiently, which is hardly ever the case in real life. If private markets were able to provide efficient outcomes and if the distribution of income were socially acceptable, then there would be little or no scope for government. In many cases, however, conditions for private market efficiency are violated. For example, if many people can enjoy the same good at the same time, then private markets may supply too little of that good.
The existence of market failure which occurs when private markets do not allocate goods or services efficiently provides a necessity for governmental provision of goods and services;
(2) Distribution of income. Some forms of government expenditure are specifically intended to transfer income from some groups to others. For example, governments sometimes transfer income to people that have suffered a loss due to natural disaster. Likewise, public pension programs transfer wealth from the young to the old. Other forms of government expenditure which represent purchases of goods and services also have the effect on changing the income distribution. For example, engaging in a war may transfer wealth to certain sectors of society. Public education transfers wealth to families with children in these schools. Public road construction transfers wealth from people that do not use the roads to those people that do (and to those that build the roads);
(3) Macroeconomic stabilization. It is a category which describes the effects of monetary and fiscal policy on the economy. Fiscal policy relates to government spending, taxation and borrowing. It affects businesses in a variety of ways: companies might try to minimize their tax liabilities, possibly by transferring business operations to low-tax countries, the investment decisions by companies could be effected by tax. For example, the government might offer some tax relief for new investments, and companies will expect to receive tax allowances for capital investment, customers’ spending decisions could be effected by the rate of sales tax or value-added tax. If the government increases the level of value-added tax, the volume of customer demand for the goods and services of companies will probably fall.
Thus, we can figure out that public finance has the following four functions: a) the provision of essential services; b) the encouragement or control of particular sectors of the economy; c) the implementation of social policy in respect of social services, and d) the encouragement of the growth of economy as a whole.
The major instrument of any financial system is the budget. In a market-oriented economy, the budget is the most important tool for achieving national priorities and goals through the allocation and distribution of resources, and the maintenance of a stable macroeconomic environment.
The budget is an estimate of national revenue and expenditure for the ensuing fiscal year. When expenditure exceeds the revenue the budget has a deficit.
Revenue and expenditure forecasting is the most fundamental step in the process of budget preparation. Adequate planning of recurrent and capital expenditure depends critically on an accurate forecast of revenue availability. The determination of the expected overall deficit in the public sector and therefore the macroeconomic impact of fiscal policy requires accurate forecast of tax collection and expenditures.
Public finance is a sum of budgets of all levels of subjects, extrabudgetary and reserve funds.
An accurate revenue forecast is most critical at government levels but it is also important for all subnational governments because over the last several years they have worked with increasingly autonomous budgets.
Budget preparation at the state level involves a number of institutions. The Ministry of Finance (MoF) is the central coordinating institution in charge of compiling and presenting the budget. It has major inputs from ministries in various sectors of the economy and the state tax bodies.