The Action Taken Report on the recommendations of the Thirteenth Finance Commission (TFC), tabled the day before the Union Budget, gratifyingly accepts all its major provisions. A tradition has built up over the years whereby Finance Commission prescriptions on the core task assigned to it are accepted in totality by the government of the day. A good practice in general, this averts the kind of disastrous part-acceptance, for example of Pay Commission reports, which has played havoc with fiscal discipline. There are downsides to the practice as well. Finance Commissions become excessively risk-averse about departing from the trodden path, in a bid not to go down in history as the first to have been partially rejected. But more on that in a future column.
Only a few of the recommendations of the TFC are set aside for further examination. These include the interest rate reset on the National Small Savings Fund loans to states, accounting and budget reforms, and disclosure requirements. Some disclosures, such as on state-local transfers, are actually built into the fabric of fully-accepted recommendations, so it is those pertaining to the Centre that are set aside for consideration. Finance Commissions have no instruments in any case with which to enforce or incentivise their recommendations for the Centre. But in many ways, these are arguably of even greater importance for fiscal discipline in the system than incentives formally built into the transfer mechanism, which in the very nature of Finance Commissions, apply to sub-national governments alone. For example, the Centre has to take the lead in removing structural shocks from Pay Commission arrears by making the pay award commence from the date of acceptance. Pay Commission salary revisions apply to Central civil servants in the first instance, but within an interval of a few years work their way through all states. Arrears from back-dated Pay Commission awards were a major fiscal overload on states during 2008-10, as much or more than the revenue impact of the global slowdown.
The TFC treated the first year 2010-11 of its five-year horizon as a gap year in which both the Centre and the states were given room to begin reversal of the fiscal loosening of the last two years. The formal correction horizon for the states actually begins only from 2011-12, with a year given to them in which to enact legislation carrying the state-specific time path prescribed in the report. For the Centre, the correction path prescribed by the TFC does start right from 2010-11, but the deficit targets for the first year are actually more lax than in the Centre’s own Medium Term Fiscal Plan (MTFP) accompanying last year’s fiscal policy statement in July 2009. The TFC was driven by the objective of prescribing feasible targets in place of infeasible promises.
But the latest Union Budget, while staying with its original MTFP fiscal deficit of 5.5 per cent, actually has a whopper of a revenue deficit of 4 per cent. So, we have fiscal exit, yes, but doing this through capital expenditure containment is a bad idea in the midst of a stark infrastructure deprivation. The state of water, sewerage, road and power infrastructure in India is no secret. We creak on in the midst of it all. Where Plan capital expenditure grew 25 per cent last year over 2008-09, growth is contained at 14 per cent in the year to come. Where Plan revenue expenditure grew last year at 13 per cent, it is budgeted to grow at 19 per cent next year.
An influential body of opinion holds that the revenue deficit does not matter. Capital markets, they will argue, care about the reach of the government into the supply of financial savings, not about the expenditure uses to which those borrowings are put. Keynes himself, the saviour in 1936 as in 2008, said of fiscal expansion during a downturn that it could just as well be spent on digging holes and filling them up. And conversely, when the budgetary imbalance is being reversed, could it not be argued likewise that the kind of expenditure curtailed is of no importance?
Keynes in the 1930s was fighting a fire, and was rightly impatient with classical economists at the time who worried about the longer term implications of deficits, when there was a short-term imperative to jump-start a stagnant system. We too are fighting a fire no less urgent, the demographic pressure on infrastructure that will be felt five or ten years down the line. The capital expenditure to avert that has to happen now.
The problem with present budgetary practices is that Plan revenue expenditure, feeding into the revenue deficit, actually has capital expenditure components tucked away in it. Of the total Plan revenue expenditure of Rs 3.15 lakh crore budgeted for next year, some goes as assistance to state and Union Territory plans, leaving Rs 2.3 lakh crore to be spent by the Centre. It is the Central component that has risen substantially, by Rs 43,000 crore over the revised estimate of last year, a 23 per cent increase.
Of the Central Plan revenue expenditure, 60 per cent is transferred out, most of it to a forest of autonomous implementing agencies. These include expenditure on rural roads, for example, under the Pradhan Mantri Gram Sadak Yojana, on rural housing under the Indira Awaas Yojana, and, of course, on the rural employment guarantee scheme. Disregarding asset quality issues, these transfers from the revenue account, which result in creation of capital assets, do serve to muddy the distinction between revenue and fiscal deficits. The TFC report specifically recommends that new accounting conventions, such as capital grants, be developed to handle the problem.
Transfers account for only Rs 20,500 crore of the Rs 43,000 crore increase in Central Plan revenue expenditure. Even adjusting for them does not bring down the projected revenue deficit by much. The issue remains that if an increase in current expenditure was thought necessary, at a time when the need for fiscal exit is acknowledged, the pattern and quantum of that increase have to be justified. Budget documents have to serve a clarificatory purpose for the taxpaying citizen.
The author is Honorary Visiting Professor, ISI Delhi. The views expressed are personal
