The primary deficit, which is the excess of government expenditure minus interest outgo over receipts, has almost fallen off the lexicon of economic journalists, though the official data show this number. No longer, if one wants to study India’s debt problems, since the primary deficit is the main reason for India’s rising debt-to-GDP ratio.
This point is excellently explained by C Rangarajan, currently heading the Prime Minister’s Economic Advisory Council, in this book co-authored by D K Srivastava, Director, Madras School of Economics.
The debt-to-GDP ratio rose from about 29 per cent of GDP in 1950-51 for the central government to 55.36 per cent of GDP in 2001-02, a 26.5 percentage point increase. Nearly half of this increase occurred in the first three Plans and is owing to cumulative primary deficits relative to GDP, the writers say.
A significant part of the potential build-up of debt owing to cumulative primary deficits was absorbed by the excess of real growth rates over the interest rate. However, this cushion may not be available for years to come. “With liberalisation and the end of the regime of financial repression, large excess of growth rate over interest rate may not be expected on a sustained basis,” the book says.
As such, the authors recommend that the primary deficit has to be back in focus in fiscal reforms if debt has to be contained in proportion to GDP. This is an important aspect, since much literature on fiscal reforms is based on fiscal and revenue deficits and not primary deficit.
For reducing the debt-to-GDP ratio, primary surplus will have to be generated on a sustained basis. Hence the need to focus on primary balances in an effort to control the growth in the debt-to-GDP ratio becomes unavoidable, says the book.
We all know that the government aims to bring down fiscal deficit to 4.6 per cent of GDP this financial year from 5.1 per cent in 2010-11 and revenue deficit to 3.4 per cent of GDP from 4 per cent last fiscal. What about the primary deficit? Though targets are set for the primary deficit as well, all the focus is on fiscal and revenue deficits.
As such, the book gives a policy recommendation that may change the focus of the Fiscal Responsibility and Budget Management (FRBM) Act, which was to be amended this year.
The recommendation is much more important for the states since the effective interest rate is higher in their case.
As the title suggests, the focus of the book is on fiscal transfers between the Centre and states, and here the authors, one the Chairman of the 12th Finance Commission and the other a member of the same Commission, have done a brilliant job, explaining various phases in the evolution of the Commission’s recommendations over time and the way distribution is done among various categories of states. The book also meticulously explains the theoretical presumptions in the evolution of federalism. The authors also compare the Indian system of fiscal transfer with that of Canada and Australia, the two countries known for fiscal equalisation.
The book points to another lacuna of the FRBM Act: The Act does not spell out strategies that can cope with an economic downturn. “The FRBMA is incomplete in two respects: one, it does not define a debt-to-GDP ratio that would be consistent with the need for keeping the economy on its potential growth path, and it does not define suitable limits of departure from the medium-term stance to cope with cyclical fluctuations,” they write.
It is here that the book may be accused of lacking latest information that is in the public domain. Much water has flowed since then and the lacunae pointed out by the book have been sorted out or are in the process of getting resolved.
In fact, the 13th Finance Commission recommended a target of 68 per cent of GDP for the combined debt of the Centre and states, which should be achieved by 2014-15.
“The fiscal consolidation path embodies steady reduction in the augmented debt stock of the Centre to 45 per cent of GDP by 2014-15, and of the states to less than 25 per cent of GDP, by 2014-15,” the Commission suggested.
The Commission also recommended that the FRBM Act needs to specify the nature of shocks that would require a relaxation of FRBM targets.
The very fact that the government has accepted the 13th Finance Commission’s report means that these suggestions would be carried out.
In fact, the finance ministry has already stated that amendments to the FRBM Act will be made, to provide for, among other things, deviation from the recommended fiscal consolidation path in the case of a downturn.
The authors also concede this point. They say that the chapters in the book were written before the 13th Finance Commission report was submitted. The dated information may also come in for criticism so far as the analysis of the Goods and Services Tax (GST) is concerned. The book says the issue of considering the implications of the proposed change from the Value Added Tax to GST in April 2010 is critical. Now, not only has that deadline been missed, but a year has also passed since then.
Also, the book says that both the central GST and state GST should ideally have a uniform rate. Now, the Centre has already come out with a three-year phase-wise plan for GST rates, which does not find a mention in the book.
These criticisms may be true for any other book, since much more data can come out in today’s fast-changing economic climate before a book hits the stands.
FEDERALISM AND FISCAL TRANSFERS IN INDIA
C Rangarajan and D K Srivastava
Oxford University Press
257 pages; Rs 695
