Not borrowing for current consumption, the golden rule of public finance, is at the heart of the Fiscal Responsibility and Budget Management (FRBM) Act 2003. Its pursuit continues to elude India. The experience with FRBM has been one of shifting goalposts and bypassing its spirit.
What is needed is a course correction. The Economic Survey for 2013-14 tabled on July 9, 2014, barely a month and a half after the NDA got into office, said, "India needs a sharp fiscal correction, a new …(FRBM) Act with teeth, better accounting practices, and improved budgetary management."
Fortunately, the 13th and 14th Finance Commissions have already diagnosed the problem. It was lack of transparency and comprehensiveness and inadequate monitoring and compliance. So, how to put teeth back in FRBM?
First, drop the nebulous target of "effective revenue deficit," introduced in 2012. Classifying grants into capital and revenue may serve some useful purpose for monitoring where the money is going. But writing such grants back as capital expenditure of the grantor is difficult to justify conceptually and does not find ready support in any international practice. Many international and national experts' reports argue against such a practice.
Second is the explicit annual targets, as a proportion of GDP, for reduction of fiscal (0.3 per cent) and revenue deficits (0.5 per cent) should be moved from the FRBM Rules to the FRBM Act. The Act itself may be amended by parliament, but there will be more security than rules, which the government can amend by a gazette notification.
Third is to stop the extra-budgetary operations. Government has continued to issue special securities to entities like oil marketing companies, fertilizer companies, and the Food Corporation of India in lieu of cash subsidies.
Take for example, the 'special' oil bonds, a hang-over from the days of administered petroleum prices and the extra-budgetary oil pool account (OPA). Created around the time of nationalisation of the multinational petroleum companies Indian operations in 1974-76, the OPA was a secret and complex cost-plus pricing system for producers and an equally complicated and elaborate cross-subsidisation scheme for end-users. Its aim was to protect the interests of the vulnerable sections and to insulate domestic prices from the volatility of world prices. It was meant to be a self-balancing extra-budgetary account. But, in reality, it did have imbalances in the form of surpluses and deficits. While sustained surpluses were transferred to the Budget, deficits were not. Over-dues to domestic oil companies were expected to be made up with surpluses in subsequent years.
India depends largely on imported crude. When international oil prices hardened in the 1990s, domestic companies were not allowed to raise their retail product prices adequately. Consequent losses of domestic companies were reflected in 'under-recoveries', a sophisticated term for mounting deficits in the OPA. Unwilling to borrow from the market to clear these over-dues and affect its revenue and fiscal deficit, the government issued medium or long-tenure 'special' oil bonds to the oil companies. It treated these bonds in the framework of guarantees. Their only short-run impact on the budget was the interest payable. Their major impact was postponed to when repayments fell due on maturity. The first such oil bonds, for a sum of Rs 12,984 crore, were issued in 1998-99 to seven public sector oil companies.
The administered pricing system and the OPA were abolished from April 2002. Yet, 5 per cent special oil bonds maturing in 2009 were issued again on March 23, 2004. FRBM came in 2004, but the non-transparent and 'clever' way of subsidising petroleum products and hiding its full impact on the deficit continued. The special oil bonds of 2004 were redeemed on March 23, 2009, by issuing 8 per cent special oil bonds maturing in 2026. Similarly, during the three years of 2007-2009, special bonds for a gross amount of Rs 19,890 crore were issued to 23 fertilizer companies. During 2006 and 2007, special bonds for Rs 11,200 crore were also issued to the Food Corporation of India.
The non-transparent practice of funding subsidies through off-budget borrowings and not recognising it in the revenue and fiscal deficits is a clear violation of transparency and the spirit of the FRBM Act. It destroys the comprehensiveness of the budget and understates the extent of the fiscal problem. There is a need to bring the government's liabilities on account of oil, food and fertiliser bonds into fiscal accounting.
Fourth is the need for more details in the medium-term fiscal policy (MTFP) statement. The MTFP lays down three-year rolling targets for revenue and fiscal deficits, tax revenues and total outstanding liabilities of the central government, all expressed as a proportion of GDP. What it should contain, and does not, is three-year-forward estimates of detailed breakup of major items of revenues and expenditures, together with a narrative explanation of how these have been generated. It should also specify the parameter values underlying expenditure and revenue projections and the band within which these parameters can vary while remaining consistent with FRBMA targets. The government should be required to make an evidence-based case for relaxation of the MTFP targets, should such circumstances arise.
Last but not the least, the Centre should institute a process of independent review and monitoring of the implementation of the FRBM process. The FRBM Committee Report of 2000 had recommended an autonomous Fiscal Management Review Committee (FMRC) to conduct an annual independent and public review of FRBM compliance. Implementation of FRBM Act can and should remain beyond judicial review. But, what is needed is an independent FMRC to act as Cassandra for prophesying the consequences of a set of policies. Hopefully, unlike the cursed Cassandra of Greek mythology, the FMRC's recommendation will be taken seriously by some people to inform an enlightened public debate on fiscal consolidation.
The author is an economist.
(The first of the two articles appeared on Thursday. Concluded)
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
