FRBM 2.0

Fiscal prudence is about the quality of expenditure, not just quantity

A committee to review the Fiscal Responsibility and Budget Management Act (FRBM) has suggested steep targets for achieving fiscal rectitude by the Central and state governments. A key recommendation is to move towards using public debt-to-GDP (gross domestic product) as the main variable to map fiscal performance. The committee, after running several tests and looking at the global norm, has settled at a 60 per cent debt-to-GDP ratio as the anchor, to be achieved by 2022-23. At present, India’s debt-to-GDP ratio is around 68 per cent, which makes India one of the most indebted economies among the emerging ones. In the existing FRBM approach, the focus has been solely on the fiscal and revenue deficits. The shift to the debt-to-GDP target as the medium-term goal looks logical. The committee has also recommended using the fiscal and revenue deficits as operational targets to achieve the debt anchor: By 2022-23, the former should be 2.5 per cent of GDP and the latter 0.8 per cent of GDP.

The targets, however, look quite arbitrary. For example, it is imprudent to treat the revenue deficit as merely the gap between current receipts and consumption expenditure. India needs massive spending on health care and education, which represent vital investment in human resources, without which no economy can compete effectively in the emerging, knowledge-intensive world. And if public spending in education and health care is to grow, a revenue deficit becomes unavoidable. Also, the target of reducing government debt to 60 per cent implies a virtual ban on fresh debt that is over and above what is needed to service existing debt. The recommendation of the committee in this regard looks impractical.

In his dissent note, Arvind Subramanian, chief economic adviser (CEA) and also a member of the committee, has also spoken against affixing “arbitrary” targets for debt and the fiscal and revenue deficits and has said that the government should aim to wipe out the primary deficit, which is the fiscal deficit minus interest payments, and measures whether the government collects enough revenue to meet its annual running cost. The CEA has also pointed to India's vulnerability in this regard by showing that despite reducing the general government (both Centre and states) primary deficit between 2007 and 2016, India still had much higher levels of it than global peers. The situation is made worse by the fact that these high deficits persisted even when India registered much higher growth by global standards. His suggestion is to “fix the roof while the sun shines” — that is, reduce the primary deficit while India’s growth rate is far in excess of the interest rate. More so, as unlike interest payments, which are “largely pre-determined”, the primary balance is in the ambit of government control.

The CEA’s position may give the government more room because the primary deficit for the Centre, at least, is already close to zero. As such, in his scheme, not much further fiscal correction is required. The point, however, is that while there is merit in wanting to eliminate the primary deficit, this approach is more suited for developed economies, where tax revenues are higher and demands on government for capital expenditure are far more modest. A zero primary deficit would make it impossible to borrow for capital/infrastructure projects unless there is a substantial revenue surplus. For a country like India, fiscal prudence must take into account the quality of expenditure and not just the quantity.