Budgetary Forecasting in India: Partitioning Errors and Testing for Rational Expectations

According to the theory of efficient markets, economic agents use all available information to form rational expectations. Fiscal marksmanship, the accuracy of budgetary forecasting, can be one important piece of such information the rational agents must consider in forming expectations. Using Theil’s inequality coefficient (U) based on the mean square prediction error, the paper estimates the magnitude of errors in the budgetary forecasts in India for the period 1990-91 to 2003-04 and also decomposed the errors into biasedness, unequal variation and random components to analyze the source of error. The test of rational expectations revealed that neither revenue nor expenditure forecasts in India is rational. However, capital budget revealed more forecast errors than revenue budget. The results also revealed that degree of errors in forecasting of receipts was relatively higher than that of expenditure. However there is no specific trend in the forecasting errors, which reveals that budgetary estimates are made not based on adaptive expectations. The proportion of error due to random variation has been significantly higher (which is beyond the control of the forecaster), while the errors due to bias has been negligible. The analysis related to efficiency of forecasts also showed that no significant improvement in forecasts over time.