Indian economy: Combine prudence with growth
The new law must focus on fiscal stability and debt sustainability. This could reposition India’s macro-economic strategyanalysis Updated: Mar 29, 2016 21:53 IST
It is a no-brainer that we must live within our means. What is true of individuals is true equally of nations. Fiscal responsibility emanates from this principle, which also influences inter-generational and distributional choice. The saying ‘blessed are the young for they shall inherit the national debt’ is a curse.
One of the more sagacious features of the Union Budget has been to re-visit the flawed Fiscal Responsibility and Budget Management (FRBM) Act, which was a contextual response to a deteriorating fiscal situation. The prescriptive ceilings in the Act have a dubious rationale. We need an approach that focuses on multiple variables, particularly debt. It would also be appropriate to suggest a range than a fixed number.
For long, the focus was on the budget deficit and not the fiscal deficit, which is of more recent origin. The recommendations of the Sukhamoy Chakravarty Committee on Monetary Policy (1985) talked of the need for fiscal discipline. In the initial years, India adopted a somewhat conservative fiscal policy approach and public debt was controlled. It was during the 1980s that both debt and the fiscal deficit started rising. By the 1990s, the economy was in a deep balance of payments (BoP) crisis with the fiscal deficit of the central government exceeding 8% of GDP compared to the 6% of the 1980s. The deficit had to be met by enhanced borrowing. As a result, the internal public debt rose to 55% of GDP. Interest payments, alone at 4% of GDP, constituted 20% of the expenditure. The reforms of 1991 were a major stabilising factor in the enveloping fiscal and BoP crises.
The Asian meltdown of the 1990s could have unsettled our macro-economic parameters, but the economy not only weathered the crisis but grew at 8.8% in 1999-2000. Debt service as a proportion of the current account deficit dropped from one-third to less than one-fifth, although the fiscal imbalance remained worrisome. The large revenue deficit was a recurring annual feature and worsened from 3.3% in 1991 to 4.4% in 2002-03.
It was against this backdrop that a committee headed by EAS Sarma was constituted and the FRBM Bill was presented in Parliament in December 2000. It was referred to the Parliamentary Standing Committee on Finance and the panel objected to stipulating specific numerical ceilings and inflexible timeframes for attaining the levels prescribed in the Bill. The committee believed that these would induce rigidity in decision-making. Nevertheless, Parliament passed the FRBM Bill in 2003 and notified it in 2004. The Act set the target of reducing the fiscal deficit to 3% of GDP by 2008-09 with an annual reduction of 0.3 percentage points. It sought to eliminate the revenue deficit by 2007-08 (later revised to 2008-09 through an amendment) through an annual reduction of 0.5% percentage points.
In February 2005, regrettably then Union finance minister P Chidambaram pushed the pause button, alluding to the 12th Finance Commission’s recommendations. There was also the burden of the Sixth Pay Commission, an aggressive farm loan waiver and expansion of the NREGS to all the districts. Revenue deficit elimination was postponed to February 2008 and in the context of the global meltdown, the FRBM targets were again relaxed. In February 2012, the FRBM Act was amended to postpone the targets to 2015 and subsequently to 2018.
Thus, the FRBM has had a chequered history of repeated amendments rather than adherence, of exception rather than compliance. Perhaps the 3% fiscal deficit target mentioned in the original FRBM Act is opaque in its intellectual persuasion. It is reiterated elsewhere that the idea originates in the Maastricht Treaty of 1992 and not in an analysis of India’s socio-economic conditions and other related factors. The Maastricht Treaty had outlined five convergence criteria including the budget deficit target of 3%, a debt-GDP ratio below 60%, an inflation rate of 1.5% or less, and interest rate changes.
The Budget’s announcement of a committee to review the FRBM Act is therefore timely. Fortunately India’s debt-GDP ratio is significantly lower at 66.1% from the historic high of 83.3% in 2003-04. Private investment remains subdued. Enhanced public expenditure and capital-creating assets is the path forward. With improved implementational capability, private investment invariably piggybacks on enhanced public outlays.
The Act replacing the FRBM law may be called the macro-economic stabilisation Act. The focus must be on debt sustainability. This review committee must consider multiple indicators of fiscal stability, beyond the revenue and fiscal deficits. An absolute limit must be replaced by a flexible/optimal limit for debt levels. By fixing optimal debt levels, the revenue and fiscal deficit targets should suggest a band. They need to be circumstance- and country-specific, rather than replicate variables adopted elsewhere. The IMF Staff Position Note of September 2010 states that “prudence dictates that countries target a debt level well below the limit, the limit delineates the point at which fiscal solvency is called into question”.
Importantly in the Indian context, the review committee must consider the fiscal deficits of the state governments. While the combined fiscal deficit of the states has stayed at 2.5% of GDP or less, there are significant differences among them in fiscal prudence, and the fiscal health of the power utilities constitutes a key vulnerability.
The new law is an opportunity to reposition India’s macro-economic strategy. We need to combine prudence with growth. It takes less imagination to incur expenditure than create income. Fiscal fixation is less relevant than meeting debt obligations even though they are inextricably related.
NK Singh is a member of the BJP and a former Rajya Sabha MP
The views expressed are personal