Charting the fiscal roadmap

Fiscal developments in India have taken so many turns over the past few years, that any analysis of the field runs the grave risk of becoming dated rapidly.

Who would have believed that the finance ministry and the Reserve Bank of India (RBI) would have the nerve to plump for an instrument like the Market Stabilisation Fund, even a couple of years ago.

At a conservative estimate, the measure is expected to add Rs 3,000 crore to the Centre's expenditure per annum. It is now a matter of days before the bonds to mop up Rs 60,000 crore of excess liquidity hit the markets.

But hardly any economist has found fault with the measure. In other words they are convinced, that the finance ministry will have the self control not to dip into the proceeds, which will be parked in the public accounts, as per the agreement worked out between North Block and Mint Road.

The logical corollary is that the economists are also generally convinced that the Centre will be able to absorb the rise in expenditure without any rise in fiscal deficit.

That's quite a change from events as recent as 1999-2000, when the finance ministry's move to rein in fiscal deficit by firewalling the proceeds from the small savings into a Fund, received a generous dose of flak.

But that again is substantially different from the happenings in the current fiscal. The finance ministry has for the first time earned Rs 690 crore through investment income of its surplus cash. Throughout 2003-04, the ministry has been able to approach the markets at the most opportune time.

As a result, the ministry has been able to avoid charges of pre-empting liquidity from the markets, and has been able to announce that for the first quarter of next fiscal, it will resort to reduced borrowings.

The implications for the banking sector for instance, which has earned the lion's share of its profits by investing in the securities market, way below the stipulated amount will be something quite remarkable.

What impact these measures would have on the fiscal policies are a difficult question. The collection of papers presented at the India: Fiscal Policies to Accelerate Economic Growth organised by the NIPFP and the World Bank in 2002 do however provide very useful pointers to these questions.

That the volume is jointly edited by Edgardo M Favaro and Ashok Lahiri makes the expectations even more keen. In the introductory chapter, the two authors bring out the perils of continuing along the high revenue deficit and high fiscal deficit path for India, which leads to progressively lower space for discretionary action by the Centre.

The alternative to reducing fiscal deficit leaves no room for augmenting public investment from its current low levels.

Among the 12 papers in the book, Fiscal Policies and Sustainable Growth In India, leaving out those which explore specific sectors, the conclusion is that the present fiscal position of the Centre and the states is not sustainable.

The basic reason why it has not imploded is that the Centre and of course the states have financed their borrowing from internal sources rather than from abroad.

But after that the story gets murky. For instance again as Lahiri and Kannan argue because of the declining inflation rates, the fiscal deficits of the past few years are effectively higher.

"The past three year's fall in inflation may not be permanent unless tight monetary policy is accompanied by permanent increase in tax revenue and cuts in government spending", they argue.

None of the authors dispute the point, though one wonders whether the problem of inelastic tax is more a result of lack of reforms in the tax administration, than just the impact of the fall in indirect tax like customs.

Why for instance has no step being taken to tax charitable institutions, and why has there been a rush for granting exemptions for backward areas?

Writing on service tax, M Govinda Rao explains how exclusion of services and agriculture from the sales tax base facilitates tax evasion through transfer pricing policies.

There is also need to ponder which steps are really possible to cut back government expenditure. As EAS Sarma shows, instead of trying to persist with the attempts to cut back subsidies, which the present finance minister has all but given up, the plan expenditure has a lot of potential.

The work to reduce over centralisation, and indiscriminate extension of programme coverage can be much more productive to restore the fiscal health of the states than many other measures.

The dichotomy between the expenditure responsibilities, which the states are expected to carry and the limited revenue raising powers assigned to them is discussed by Mukesh Anand, Amaresh Bagchi and Tapas Sen.

They argue for a need to impose hard budget constraints to make the states reduce their dependence on soft borrowing from the market and the Centre. Their analysis highlights the point that both institutional and political forces have to work together to bring about financial discipline.

In the context of the disastrous announcement to merge DA and basic pay of central government staff, which will be replicated by the states very soon, the comment is just one more classic reminder.

Fiscal Policies And Sustainable Growth in India

Edited by Edgardo M Favaro & Ashok K Lahiri
Oxford
Price: Rs 595