Subir Gokarn: Priorities, politics, and deficits

What is needed is increased dedicated funding for government programmes

It appears that the government is quickly realising the many advantages of "dedication"""not in the traditional sense of the term, but in a concrete and practical way.

In fiscal terms, this involves the tying of expenditure programmes to specific sources of revenue. In recent times, the most significant examples of this approach are the National Highway Development Programme and the rural roads programme, both of which were funded by the cess on petrol and diesel.

The UPA government also ventured down the dedicated funding path by imposing the education cess, which was estimated to raise over Rs 4,000 crore in the current year. Last week, it took a huge step forward in this direction in setting up the National Investment Fund.

To many observers, the momentum that privatisation had achieved during the previous government's tenure seemed to have died out completely.

Yes, there was the Rs 4,000 crore target in the July budget and there was the successful IPO from NTPC. But, the rhetoric and the "body language" were clearly against it.

It appeared that the political energy required by supporters of the strategy to persuade its many opponents would simply prove to be too much.

It was only the pressure of falling short of deficit reduction targets that had revived the prospects of further sell-offs.

I have argued in previous columns (the latest on June 7, 2004) that dedicating the proceeds from privatisation to specific pre-announced spending programmes was the only way to break down political resistance to it.

My argument had a regional focus. There is a concentration of public enterprises in the eastern part of the country, which is an important reason why political parties with a strong power base in that region are among the most vociferous opponents of privatisation.

Why not, then, assure each state that a reasonably large proportion of the proceeds from privatising assets located in its territory would flow back to it?

While the regional dimension has not been explicitly spelt out, the basic principle of dedication is embedded in the concept of the national investment fund.

It seeks to create a corpus from the proceeds of disinvestment (privatisation is destined to remain a dirty word in the political lexicon).

The returns on this corpus will be spent on social sector development programmes and revival programmes for selected public enterprises.

The quantum of spending on programmes covered by the fund is obviously going to be determined by the size of the corpus, which, in turn, will depend on how much the government is able to raise through disinvestment.

This is the notion of "incentive compatibility" built into dedicated fund arrangements, which make them so attractive as an instrument to reconcile political differences on fiscal management.

The other implication of dedication, and it is a huge one in India's current context, is that the deficit is insulated from an expansion of expenditures, which are financed through this arrangement.

Several objectives are, therefore, being simultaneously being addressed by a common strategy. Programmes that have a high political premium are finding resources.

Programmes that are difficult to sell politically but are seen to pay off in the long run (like disinvestment) are sustained. And, deficit reduction targets are not compromised.

But, like any powerful instrument, dedication can also be double-edged. Its limitations and the risks associated with these must be fully appreciated.

The first question is with respect to the predictability of the revenue sources that are being dedicated to programmes that would obviously have a high political priority.

In the specific instance of the National Investment Fund, the concern is whether the incentive compatibility is strong enough to ensure that a steady flow of government-owned assets is sold off every year.

If, for whatever reason, this doesn't happen, does the government's commitment to the programmes being funded still stand? In which case, it would have to be funded out of general revenues, resulting in either a re-allocation of expenditures, or deficit pressures, or both.

In an optimistic scenario, dedicated funds, which are not vulnerable to year-to-year expenditure decisions, reduce funding risk for individual programmes and thereby allow for better long-term planning and a more efficient balance between capital and revenue expenditures.

However, if the dedication is tight, so that the programme has no recourse to general revenues, the volatility of the dedicated revenue source directly translates into funding risk.

Successful dedication depends on linking relatively stable revenue sources to programmes that are heavy on investment and maintenance.

Highways and roads are a typical example of this; funding them through a fuel cess made eminent sense because fuel consumption growth is very stable.

However, as one goes down the list of possible sources of dedication, it becomes increasingly difficult to find sources that are both large and stable.

As the scope of dedicated funding increases, the risks associated with the volatility of the source will inevitably increase.

Then, there is the critical question of accountability. In a general budgeting process, when programmes are not guaranteed funding year after year, it is always possible to pull the plug if the programme is not delivering.

Of course, one might argue that as far as the Indian government is concerned, this is hardly a credible threat in most instances, but that is a broader comment on the state of financial accountability in public services.

Whatever standards of accountability there may be, the fact is that programmes with dedicated funding must be subject to a stricter standard than those which are not thus privileged.

For the government, providing this kind of explicit guarantee of long-term funding signals the priority it puts on the programme. There will inevitably be heightened public sensitivity to the performance of the programme.

A perception of failure could rebound more strongly on the government than for a run-of-the-mill programme. More so, the act of dedication usually involves the setting up of some kind an institutional mechanism.

This makes it difficult to reverse. Every year in which money is seen to be going down the drain in pursuit of unachievable objectives is a year lost for another, possibly more effective, programme.

Increasing the degree of dedicated funding for government programmes is definitely the direction the government must take if it is to find a sustainable balance between priorities, politics and deficits.

But, it needs to back this up with a credible system for managing funding risk for priority programmes and, most importantly, subject them to stricter scrutiny and standards of accountability.

(The author is chief economist, Crisil. The views expressed are personal)