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Governance and the deficit debate

The crux of the arguments for a fresh rethink on deficit financing is that Governmental intervention, especially in social sector spending, is inescapable and any extemporised limits should not constrain it.

Despite its near euphoric performance in recent years, a number of structural imbalances continue to plague the Indian economy. Amongst these, the large deficit, both at the Centre and in the States, has remained a near permanent distorting feature of the Indian economy; its Achilles heel, as it were. Ever since the initiation of reforms and despite attempts by successive Finance Ministers in reducing deficits, the progress made till date are marginal and the consequential benefits minimal.

It may be noted that reduction of deficits read fiscal discipline and with it, a reduced role for the state has been the quintessence of reforms. Nevertheless, even as the benefits of adhering to fiscal discipline manifest slowly, India once again revisits the subject of controlling deficits.

Ever since Mr Prakash Karat, the CPI (M) leader, questioned the orthodoxy associated with controlling deficits and called for a return to Keynesian economics, the issue of meeting deficit reduction targets, as mandated by the Fiscal Responsibility and Budget Management (FRBM) Act, has left economists deeply divided.

Scrapping FRBM Act
By virtually calling for scrapping the FRBM Act that places constraints on attaining certain social objectives of the government, Mr Karat has placed the debate on controlling fiscal deficits at the national economic centre-stage.

Ever since this call, there seems to be a rethink within a section of the establishment too on this fundamental issue. The Eleventh Plan Approach Paper suggests increases in Plan size depending on the deficits.

Realising the constraints involved in either increasing revenues or reducing expenditure in the present context, the Approach Paper justifies the need for dilution of FRBM targets and states: "The FRBM requirement calls for a reduction in the fiscal deficit of the Centre and the States combined by about 1 per cent of GDP in the first two years of the 11th Plan. This means the increase in resource availability will be relatively modest in the first two years, followed by fairly sharp increase thereafter. This has the consequence that some of the Plan expenditures needed for making growth more inclusive may have to be postponed."

Joining the debate on this issue, the former Reserve Bank of India Governor, Mr S. Venkitaramanan, in an article titled "Thinking out of the Fiscal Cap" (Business Line October 16) stated, "I have been suggesting that RBI/Centre should put on their best thinking caps and arrive at reasonable limits, which take into account the various implications of a rigid fiscal cap."

Arguing that committing to a rigid fiscal deficit cap could come in the way of achieving economic growth, which alone can pull the economy out of its present social and infrastructure deficits, he pleaded that achieving growth was more important than attaining fiscal purity.

Another crisis looming?
While these arguments are indeed persuasive, the counter-arguments for a stricter fiscal regime are in fact compelling.

Apart from the persistent presence and quantum of deficits, what is worrying economists is that the percentage of revenue deficits as a proportion of the fiscal deficit for the Centre has increased from under 50 over a decade ago to approximately 65 now.

Moreover, as on date the Union Government's interest bill virtually corresponds to the fiscal deficit. Naturally, India continues to reel under infrastructure deficits.

With more fiscal pressure in the pipeline in the form of increased pay to government employees through the Sixth Pay Commission, the rising burden of social commitments flowing from the Common Minimum Programme and the virtual standstill of the disinvestment process the worrying issue for many economists is that the `government-debt-to-GDP' ratio recently crossed the 80 per cent mark.

For many, it would seem that the dark clouds of another financial crisis are looming over the Indian macroeconomic horizon.

Fiscal profligacy
In this connection, the RBI has repeatedly warned of fiscal profligacy negatively impacting the robust growth pattern. For instance, its Annual Report for 2005-06 cautions, "Notwithstanding the fiscal consolidation in recent years, the combined fiscal deficit continues to be high by global standards.

The persistence of large deficits over the past decades has resulted in high level of public debt, currently around 80 per cent of GDP. Furthermore, revenue deficits continue to remain high." It therefore opines that, "Determined measures for fiscal consolidation would be necessary to achieve the declared FRBM targets so that the current growth momentum of the Indian economy can be maintained."

Fresh think?
The crux of the arguments put forth by many arguing for a fresh think on the issue of deficit financing is that governmental intervention, especially in social sector spending, is inescapable and any extemporised limits should not constrain it.

The arguments of those who seek a flexible approach to deficit financing seem to suggest that the FRBM Act is likely to impose severe constraints on financing social sector expenditure and infrastructure initiatives of the government.

While this argument (for a move away from fiscal orthodoxy) is morally acceptable, popularly engaging and perhaps even politically correct, it remains a weak economic argument in the current Indian context.

Put pithily, the issue is not merely of deficits. Rather, it is their composition, with a significantly growing revenue deficits that is at the root of the present consternation.

Consequently, what is further denting India's growth potential is that valuable domestic savings, which would otherwise be available for investments, are getting (mis)directed to finance profligate expenditures.

Anything multiplied by zero is zero
Crucially, what is lost in the melee is that given the quality of governance, increased outlays on capital or revenue account do not necessarily translate into outcomes in the Indian context. It would be naïve to suppose that any increase in deficits, even if it were substantial, would make the dysfunctional public schools and hospitals functional or make the potholed roads smooth.

Given the quality of governance, merely by increasing revenue and fiscal deficits one cannot remedy social and infrastructure deficits. The debate on governance and accountability, which is conspicuous by its absence now, must precede the debate on deficits.

Due to the lack of proper governance India runs the risk of pouring good money down the drain and thereby engineering a financial crisis. After all, anything multiplied by zero is zero.

Fortunately for the nation, the Finance Minister, Mr P. Chidambaram, despite pressures from many quarters, has refused to yield to the rising chorus of demand for fiscal relaxation.

In a letter addressed to the Deputy Chairman of the Planning Commission justifying the need for fiscal discipline, he is reported to have written: "You do not repair a leaking supply pipe by simultaneously stepping up the water pressure."

The Finance Minister's metaphor seems to have settled the debate and rightly so in favour of fiscal discipline. Till governance is improved, the debate on fiscal relaxation can wait.

Published at: http://www.thehindubusinessline.com/2006/12/15/stories/2006121500790800.htm

Last modified on Sunday, 07 July 2013 07:36

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