Issues And Concerns
By Siba Sankar
25 April, 2004
Fiscal Responsibility and Budget Management Bill, 2000, has been enacted
in Parliament. The Act is based on the presumption that the fiscal deficit
is the key parameter adversely affecting all other macroeconomic variables.
It is argued that lower fiscal deficits lead to higher as well as sustainable
growth and higher fiscal deficits apparently lead to inflation. It is
also argued that large fiscal deficits may lead to huge accumulation
of public debt.
However, many development
economists like C. P Chandrasekhar and Jayati Ghosh argue that if the
fiscal deficit is dominantly in the form of capital expenditure, it
contributes to future growth through demand and supply linkages, and
in fact can create so much demand in the economy that private investment
may crowd-in to supplement autonomous investment. As far as inflation
is concerned, it results from an excess of aggregate demand over aggregate
supply and there can be higher inflation with low, zero or even positive
fiscal accounts. This may happen because of excessive spending by the
private sector over and above its earnings, as was the case with many
South Asian countries before the currency crisis.
There is nothing
wrong in maintaining large fiscal deficits if resorting to public debt
is made only to meet investment requirements as long as their social
rate of return is higher than the rate of interest. Deficit per se is
not bad as the Indian economy is a demand-constrained economy. Due to
existence of underemployment of resources and production at much less
than its optimal level, the economy can actually sustain a high level
of fiscal deficit up to around 7-8 percent of GDP. Even in case of revenue
deficit, if it is properly managed will help pumping in purchasing power
to the economy and boost demand keeping in mind the persistently low
level of inflation during recent years. In India, it is not the problem
of growing deficits, which deserves concern but the composition for
these deficits and the way these are being financed.
The Government aims
to eliminate revenue deficit by 31st March 2008 - in turn leading to
revenue account surplus, and possible progressive reduction of capital
account liabilities. Elimination of revenue deficit requires a balance
in revenue accounts, which can be done by reducing revenue expenditure
drastically, or by enhancing receipts to fill the gap, or by trying
both. The Government can substantially reduce revenue expenditure if
a reduction is at all possible in those items, which constitute a major
part of total revenue account. For example, interest payment alone takes
away around 30 percent of the total expenditure. But unfortunately it
is charged on the Consolidated Fund of India. The government, in no
way, can actually reduce this expenditure till 2008 except deferring
a part of it, which will further aggravate the fiscal situation. The
government of the day will never compromise with defence expenditure
particularly in a situation where the people in the government visualise
threats to national security from all possible corners of the world.
So if the government of the day tries to reduce expenditure it may do
so in crucial sectors like social services and some of the economic
services only. This will affect the all-round development of the country
and further aggravate the fiscal situation.
In the receipts
side, dividends and profits to the central government from its investments
is less likely to grow in view of the disinvestment policies, the government
is pursuing, for the PSUs. Unfortunately the skimpy amount the government
could raise from disinvestment is also being spent for current expenditure.
The trend of our government's commitment towards direct tax is clear
from populist announcements of tax concessions in the budget speech.
The government can go for more indirect taxes in order to mobilise more
receipts. But it will actually reduce the overall demand further, through
its impact on the purchasing power of the consumers. Even then, it is
not a possible solution in case the government implements VAT in the
country. VAT not only requires much higher tax rate on the value added
in order to get the same revenue, but will also lead to revenue loss
for the states and affect the distribution of revenue among the states.
The Act provides
that the central government shall specify the annual targets of assuming
contingent liabilities in the form of guarantees and the total liabilities
as a percent of GDP. During last four years, the gross annual liabilities
are growing at more that 14 per cent per year. In the 2003-04 budget,
the government proposed an internal debt, which is around 12 per cent
higher than the revised estimates for 2002-03. Has the government shown
any respect to this law in its own activities?
As per Sec.4 (2)
of FRBM Act, deviations from targets are allowed in case of exigencies
like national calamity or national security. With situations like drought
to a Kargil War every year, non-achievement of targets could be a normal
As a self-imposed
discipline the government will not borrow from RBI except to meet temporary
excesses of expenditure. What if such excesses of temporary nature occur
Therefore, the optimism
expressed in FRBM Act towards eliminating the revenue account deficits
is only a misnomer. Will any government take steps to reduce unproductive
expenditures? No doubt, India needs a policy for fiscal prudence -but
FRBM in its present form is not the answer.
(The author is a
Research Analyst at Centre for Budget Accountability. Email: email@example.com