T C A SRINIVASA-RAGHAVAN: How to manage the deficit

OKONOMOS

The fiscal deficit can be stabilised at 6 per cent, with the debt-GDP ratio eventually stabilising at 56 per cent

Before the balance of payments crisis of 1991, no one paid much attention to the fiscal deficit. Indeed, the term was largely unknown in India. Instead, attention used to be on the budget deficit.

Since 1991, however, few things have occupied the mind-space of Indian economists as it has. The reasons may differ but the goal remains the same: reduce the pre-emption of savings by the government, which wastes it all.

The issue at stake is not hard to understand. Basically, it revolves around how much the government should borrow. Usually, the amount is expressed as a percentage of the GDP. Below 5 per cent is regarded as being safe.

But when borrowings go above that level, two sets of issues arise. One pertains to the sustainability of the debt if the government goes on borrowing furiously.

The other pertains to the concerns of foreign lenders who, even if the government doesn't repudiate its debts, run the risk of a devaluation that would lower their returns. The IMF represents these foreign lenders, which is why it goes on and on about the need to keep the fiscal deficit low.

My view is that we should not worry about the concerns of foreign lenders. They should manage the risks attendant on their greed themselves.

But sustainability is definitely an issue, for two reasons. One is historical; and the other contemporaneous.

The historical reason is that indebted sovereigns always lose their sovereignty or it gets abridged. The contemporaneous reason is that we all lend to the government and don't want to see our savings disappear.

The one man who is singularly qualified to express a view on both aspects is Dr C Rangarajan, currently the chairman of the Prime Minister's Economic Advisory Council. He is a former Governor of the Reserve Bank of India and a former Chairman of the 12th Finance Commission.

Along with his colleague D K Srivasatava, Rangarajan has written a paper* that focuses on how to get there from here. The "here" is a debt/ GDP ratio in excess of 80 per cent. The "there" is a ratio of around 56 per cent.

Towards this end, the paper says that it is imperative to increase the overall savings ratio leading to a rise in the investment ratio. The way to do this, it says, is to manage the revenue and fiscal deficits sensibly.

"The process of adjustment can be considered in two phases: adjustment phase and stabilisation phase. In the adjustment phase, the fiscal deficit will have to be reduced in each successive year to a level, which is less than the level of the fiscal deficit relative to GDP that will stabilise the debt-GDP ratio at the previous year's level. This phase should be continued until the revenue deficit is eliminated."

The fiscal deficit can then be stabilised at 6 per cent, with the debt-GDP ratio eventually declining to and stabilising at 56 per cent. "At this level of the debt-GDP ratio, it is estimated that the interest payment to revenue receipts ratio, under given assumptions, would fall to 17 per cent."

It is this decline that will release the resources for spending on the things that should matter to governments: health, education and urban infrastructure.

In this context, the paper makes another important observation that requires legislative remedial measures. This is that the FRBM Act "... is incomplete in two respects. One, it does not indicate a suitable level of the debt-GDP ratio along with the specified fiscal deficit target; and second, it does not provide for a suitable strategy for coping with short-term fluctuations."

But, by definition, short-term fluctuations, being unpredictable, are difficult to cope with, at least in the sense that you cannot have a strategy for them, other than by stowing a wad of notes under the mattress.

Nor can you anticipate what Bunty and Bubli might get up to while egging on the Employment Guarantee Bill and the notion of pensions for the unorganised sector.

*Fiscal Deficits and Government Debt Implications for Growth and Stabilisation EPW, July 2, 2005