Fiscal virtue cannot be legislated. It must be implemented and enforced. | |
| There has been a lively debate about the relative merits of rules versus discretion in the context of defining for the RBI an inflation target that it will be bound by when conducting monetary policy. While there are differences, an important perspective may be obtained by examining the track record of a (legislated) rule that the central government has imposed on itself regarding the other half of the aggregate demand "scissors", namely, fiscal policy. The Fiscal Responsibility and Budget Management Act (FRBMA) was legislated in 2003, with the rules (framed in July 2004) requiring that the central government's fiscal deficit should not exceed 3 per cent of GDP by 2007/08 and that the deficit on the revenue account would have been eliminated by the same date (taken together the 'golden rule' implication is that the government will borrow only to invest). There are other good housekeeping clauses with regard to guarantees (increase restricted to 0.5 per cent of GDP per annum) and debt (additional liabilities are capped). The Act also required that the RBI will not subscribe to government paper after March 31, 2006. The FRBMA was amended in July 2004 with the terminal date for meeting the targets pertaining to fiscal indicators extended by one year to 2008/09. |
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If we examine the top line numerical outcomes, it is indisputable that the revenue deficit will not be eliminated and it is almost certain that the fiscal deficit terminal target will not be met. The loan waiver, pay commission award, and higher expenditure on account of oil and fertiliser entitlements virtually guarantee that the budget estimates will be substantially breached. By this yardstick, against the backdrop of the most buoyant economic cycle that the country has enjoyed, the evidence in favour of successful rules by the central government is patently thin. Furthermore, to impart sheen to the Budget numbers, an incentive to routinely indulge in off-budget accounting has been unwittingly introduced. (Within a relatively short time after disclosure in the most recent Budget that off-budget bonds worth Rs 18,757 crore were issued for 2007/08, there were reports that more bonds had been planned/issued.)
| CENTRAL GOVERNMENT FISCAL
balance (as % of GDP) | | 03-04 | 04-05 | 05-06 | 06-07 | 07-08
(RE) | 08-09
(BE) | | Fiscal Deficit | 4.5 | 4.0 | 4.1 | 3.5 | 3.1 | 2.5 | | Revenue Deficit | 3.6 | 2.5 | 2.6 | 1.9 | 1.4 | 1.0 | | Off-budget bonds* | | | 0.4 | 1.0 | 0.7 | ? | | Note: *denotes estimate; the number for 2007/08 in the most recent Budget at a Glance is 0.4% of GDP. |
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| There are three issues that are worthy of consideration if new fiscal rules are being contemplated. First, borrowing by PSUs "" which is in part due to a failure by the government to pay in full the subsidy owed "" should be incorporated in a formal canonical measure of the public sector borrowing requirement (PSBR) to gauge a (more complete) magnitude of "crowding out" arising from the government's fiscal policy. Secondly, the government should disclose (with assumptions) in its Medium Term Fiscal Policy Statement a prospective estimate of the off-Budget issue of bonds that it will be liable for in the absence of price adjustments of concerned commodities and in the absence of changes in the relevant indirect taxes. Thirdly, the "golden rule" restriction that the revenue budget be in balance or surplus requires clarity whether this means that central government borrowing should not exceed gross central government investment (including depreciation) or net central government investment (net of depreciation). |
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| The track record of fiscal rules has been generally poor. The much-celebrated European Union's Stability and Growth Pact (SGP) failed because of the absence of carrots to run larger surpluses (or smaller deficits) during upswings and the failure to enforce the penalties (including fines) that were, in principle, part of the arsenal of SGP enforcement. The failure to exercise fiscal restraint during the upswing by France, Germany and Italy was not penalised by the EU's Council of Ministers because the political cost-benefit calculus of naming, shaming and fining a leading member of the EU Club militated against enforcement of these penalties. In the case of the UK, Chancellor Gordon Brown mangled the classification of government borrowing to such an extent that its fiscal rule stands broadly discredited. |
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| In 2005, Willem Buiter and I had posed the following question in the Indian context: How much harder will it be for the Indian government to impose counter-cyclical discipline during good times on itself? Well, after a solid growth performance, with tax buoyancy to match (indeed surpass), the answer is that the Indian government has found it very hard to impose discipline on itself. Non-compliance by the government has not been politically costly; there has been little attention from the electorate, the media, or, even opposition parties to the subject matter! In fact it is widely felt that supplementary bills that boost expenditure from budgeted levels are not only unlikely to be rejected, they are welcomed with bipartisan fervour. |
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| Fiscal virtue cannot be legislated. It must be implemented and enforced "" it must be incentive-compatible even for myopic and opportunistic governments. The key is that no government has legislated a credible and prohibitive in-built cost for missing targets; even if it were to do so, for example, the FRBMA is amended to incorporate a "poison-pill" clause that states: "Parliament stands dissolved when targets are missed", political ingenuity, I suspect, will find a way out of this, or, maybe turn it to advantage! |
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| In the current year, the proximate variable that will influence the quantum of fiscal overrun is the fuel subsidy. Concomitantly, there are significant balance of payments implications. A rough back-of-the-envelope calculation suggests that for every one dollar increase in the price of the oil import basket, the current account deficit in 2008/09 widens by about 0.1 per cent of GDP. Now, the fuel bill of Indian consumers and industry is predicated on oil at less than $70/barrel; when the retail price adjustment comes about (as it must), economic growth will take a knock. urjitpatel@hotmail.com |
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