When FRBMA lines in the sand are crossed - Livemint

Fiscal marksmanship has been poor in the last several years. There are strong reasons for Jaitley to come clean and improve marksmanship even at the cost of the fiscal deficit number in the budget looking somewhat unimpressive.

What is finance minister Arun Jaitley going to announce as the fiscal deficit target for 2014-15 in his first budget speech on 10 July? In the interim budget presented on 17 February, former finance minister P. Chidambaram had targeted the deficit as a proportion of GDP at 4.1%. Should the target change in less than four months? There are two major considerations.

First, “truth in budget making”. Fiscal marksmanship has been poor in the last several years. There were large differences between the budget estimates and outcomes in 2008-09 and 2011-12. Even if 2008-09 is condoned on account of the global financial crisis, 2011-12 is difficult to justify. Unusually large supplementary demands for grants were introduced almost every year. There are strong reasons for Jaitley to come clean and improve marksmanship even at the cost of the fiscal deficit number in the budget looking somewhat unimpressive.

The pre-election interim budget carries a considerable dose of optimism. Tax revenues appear to be overestimated and expenditures understated. For example, tax revenue is projected to grow by 18% in the current year in the interim budget while such revenue was estimated to grow by only 12.9% in the previous year. Growth in nominal GDP (gross domestic product) at market prices, which is a strong determinant of such revenue, was provisionally 12.3% in 2013-14, and there are no strong reasons to believe that such growth will be substantially more in the current year.

Similarly, the total subsidy bill for the current year was targeted in the interim budget at Rs. 2.56 trillion, almost unchanged from what the revised estimate for such subsidies was in 2013-14. For the last several years, the government has rolled over some expenditure to the following year and started every year on the “backfoot” with a backlog of bills from the previous. Not paying the bills cannot be a recipe for fiscal discipline and consolidation. Jaitley should be worried now that we know that growth in tax revenue in 2013-14 fell short of the interim budget estimates by more than 2 percentage points, and the fiscal deficit for the first two months of the current year was 45.6% of the full-year target.

Apart from the “come clean” argument, there is another school of thought that argues in favour of a higher fiscal deficit target as long as the government is spending money for the “right things”. For example, Prof. Arvind Panagariya has recently argued that, in the coming budget, 4.5% is acceptable as a target if it is accompanied by an increase in capital expenditure from 1.76% of GDP to 2%. This, I believe, is an argument which is fraught with danger.

Governments all over the world always say that they are is spending money on the “right things”. It is always either capital expenditure or MGNREGA or Benazir Income Support Programme. Always, the “right things”. Even in 58 BC, when the Roman popularis tribune Publius Claudius Pulcher abolished a charge on food and began distributing grain for free, he thought he was doing the “right thing”. Later, Julius Caesar had to undo this “right thing” and cut down the number of beneficiaries to check fiscal profligacy. So, it is often wise to ask what “wrong things” the government is cutting down on to spend on the “right things”. Or, who is going to pay for such expenditure.

High fiscal deficit has been at the root of high inflation and vulnerability on the balance-of-payments front for many years. When expenditure is not financed through non-debt revenues, often people end up paying in the form of an inflation tax. Often, the effort to pass on the responsibility of paying for today’s capital expenditure to the future generations—who will benefit from such expenditure, as it will result in higher income in the future—is frustrated. Both domestic and foreign lenders are unconvinced that such expenditure, because of inefficiencies, will indeed bear the expected fruits.

The Fiscal Responsibility and Budget Management Act (FRBMA), 2003, draws a line in the sand for both fiscal (finally, 3% of GDP) and (finally, nil) revenue deficit to prevent fiscal indiscipline. Dr B.R. Ambedkar, in the constituent assembly, had foreseen the need for a law under Article 292 to restrict government borrowing and said, “If Parliament does not make a law it is certainly the fault of Parliament and I should have thought it very difficult to imagine any future Parliament which will not pay sufficient or serious attention to this matter and enact a law.” In the event, the political establishment took more than half a century to enact and notify FRBMA. The first National Democratic Alliance government got FRBMA enacted in 2003, and the United Progressive Alliance (UPA) government notified the rules and brought the Act into effect from 5 July 2004.

There was solid progress under FRBMA until 2007-08. The fiscal deficit at 2.54% was already below 3% of GDP by 2007-08. The revenue deficit had come down to 1.05% of GDP in 2007-08, and Chidambaram had announced in 2004-05 that as per the amended FRBMA, it would be wiped out by 2008-09. In the event, with the onset of the global financial crisis, FRBMA was suspended and the UPA under the Congress was back to its favourite “borrow and spend (mostly on subsidies)” policy. To obfuscate the issue of revenue deficit, it even introduced the concept of the “effective revenue deficit” (revenue deficit adjusted for grants for creation of capital assets), a concept completely unacceptable by the rules of accounting or economic principles. It is time to get back to the rigours of FRBMA.

Do the heavens fall when FRBMA lines in the sand are transgressed? No, not immediately. But indiscipline becomes endemic. Subject to “truth in budget making”, there is a lot of merit in sticking as close to the 4.1% of GDP target for the fiscal deficit.

The author is an economist.

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