T C A Srinivasa-Raghavan: Why does this pig fly?

OKONOMOS

It has been amusing, for the last several years, to see the consternation on the faces of economists. India's fiscal deficit is altogether too high, they have been saying, but yet nothing happens by way of a crisis.

Why O why does this pig fly, they have been asking passers-by, all the while muttering softly to themselves, uttering dark imprecations. Not surprisingly, another (yet another) paper* has come along to examine the mystery of the Indian deficit.

Ricardo Hausmann and Catriona Purfield first presented it at the National Institute of Public Finance and Policy (NIPFP) seminar earlier this year.

India has a jumbo-sized problem, they say, arising out of its federal system "where multiple players find it difficult to coordinate adjustment. The size and closed nature of the Indian economy, aided by its deep domestic capital market and large captive pool of domestic savings, has disguised the cost of fiscal laxity and complicated the building of a consensus on reform."

The importance of this paper, however, lies in the explanations it gives for India's ability to tolerate high deficits and debt. They say it is because of the low volatility in the debt-service-to-revenue ratio. In simple English, this means things are pretty stable here compared with other emerging markets.

That stability is the result of a very stable real output and, therefore, of real tax revenues. Things simply don't see-saw around as they do in other places.

On the financial side, it is because of the nature of the bond market, which is deep, which long-term, and which is fixed-rate and rupee-denominated. That is, we don't borrow from foreigners for short periods and we have a good savings rate and we keep it all to ourselves.

"Thus, movements in interest rates have only a small fiscal impact in the short run, while the long duration of the bond market implies that surprise inflation, even in small quantities, can have substantially positive wealth effects on the fiscal situation, allowing inflation to play a potentially stabilising role in assuring solvency."

Overall, then, at any given level of debt, India has fewer problems than others. I would have thought this is very clever of the people who manage our affairs. But the authors don't say so.

On the contrary, they call it a "double-edged sword" that helps stability but also removes the early warning signs that the whole thing is a gigantic mess in need of sorting out. Finally, there is global integration: as it progresses, volatility will increase.

So, short of avoiding global integration, what should be done? To find an answer the authors turn to India's federal system, which they say prevents fiscal rectitude.

So, they recommend "an autonomous scorekeeper and the extension of similar rules (as the FRBM [Fiscal Responsibility and Budget Management Act]) to the state governments as part of a comprehensive reform of the federal system."

This is an excellent idea in itself and needs to be pursued relentlessly even though, according to the authors, the FRBM has increased the probability of the finance ministry fudging the numbers. They, therefore, suggest an alternative.

This is to have an autonomous agency along the lines of the Congressional Budget Office in the US. This agency "would be responsible for estimating all non-discretionary budget items on revenue and expenditure.

The government and parliament would keep their current functions, but delegate the transformation of policies into projections to the autonomous scorekeeper."

They then go on to explain the operational aspects of the agency. Thus, the agency would be appointed by Parliament and its members would have long but staggered tenures. It would be required to explain deviations from estimates and present an independent ex post evaluation of its assessments.

These are very good suggestions and need to be debated in India. But I suspect no Indian economist will start off the debate because so few of them are properly equipped to discuss institutional issues.

Perhaps the finance minister should do so. If nothing else, it will divert public attention from his increasing difficulties.

The Challenge of Fiscal Adjustment in a Democracy: The Case of India, IMF Working Paper No. 04/168