MARCH 8, 2010

By Naresh Minocha, Our Consulting Editor

FISCAL reform is more a function of politics and less a function of economics. Lack of political will obviously leads to fiscal laxity.

No technique of budget management can prevent a government from borrowing to meet its consumption expenditure including staff salaries year after year as long as political leadership rises to occasion.

The Indian political class has shown the intent but not the will to bite the bullet. It is precisely because of this reason that the Finance Commission (FC) has put prevention of fiscal laxity back on the macro-economic reforms agenda.

Eliminating Revenue deficit has to get the highest priority because it represents the difference between revenue expenditure and revenue receipts. It shows increase in the Government's liabilities without corresponding increase in its assets. It shows the extent to which the Government borrows to just meet its current consumption expenditure including salaries.

In its report released on 25 February, the 13 th FC says: “The Medium Term Fiscal Plan (MTFP) should be reformed and made a statement of commitment rather than a statement of intent. Tighter integration is required between the multi-year framework provided by MTFP and the annual budget exercise.”

MTFP is one of the three reports that are to be presented under the Fiscal Responsibility and Budget Management Act (FRBMA), 2003 as part of annual Union budget. The other two reports are: Fiscal Policy Strategy Statement and Macroeconomic Framework Statement.

FC has also recommended “The FRBM Act needs to specify the nature of shocks that would require a relaxation of FRBM targets.”

Finance Minister Pranab Mukherjee has, however, avoided taking a direct and immediate call on these recommendations.

In the explanatory memorandum relating to action taken on FC's recommendations,

He thus stated: “the Commission has made other recommendations that deal with issues including revenue and expenditure reforms at Central and State levels, accounting and budgeting reforms, additional disclosures by the Centre, State and local bodies, etc. These recommendations will be examined in due course .”

Referring to FC's fiscal roadmap including fiscal and revenue deficit targets, Mr. Mukherjee, however, stated the “ The Government has accepted these recommendations in principle. Detailed proposals for amendment of the FRBM Act, as may be necessary, will be taken up separately.”

The MTFP, issued along with the Budget for 2010-11, however, shows that the Government has already shown its intent to deviate from the road-map for revenue discipline laid down by FC. And this is the first year of the five-year period over which FC recipe is applicable .

What is more alarming is the fact Finance Ministry is doing loud thinking to alter the accounting classification to window-dress revenue deficit. It has also made an attempt to rationalize the slippages in containing revenue deficit.

The emerging laxity on revenue deficit is similar to the one that emerged from the word go at the time of introduction of FRMB Bill.

The original FRBM Bill had proposed that the revenue deficit would be eliminated by

2005-06. The FBBM Act 2003 shifted this target to 2007-08. And three days after this law became effective on 5 July 2004, the Government announced its intent to amend the Act to further shift this target to 2008-09.

That even this target would not be achieved was known to the Task Force on Implementation of the FRBM Act that submitted its report on 16 July 2004.

“The task of eliminating the revenue deficit by 2008-09 appears like a distant goal,” it observed.

The electoral compulsion-caused worsening of the revenue deficit since 2008-09 is fresh in the public memory. Revenue deficit was 4.5% of the GDP in 2008-09. It increased further to 5.3% in 2009-10.

In MTFP for 2009-10, the revenue deficit target was set at 3.0% for 2010-11. And in the latest MTFP, this target has been downgraded to 4%, whereas FC has proposed a target of 3.2%.

The revenue deficit targets have been changed so often that they have been reduced to a mere game of numbers. Even the concerns over the revenue deficit have been marginalized to parrot-like utterances.

Take MTFP document for the last three years. Barring substitution of one word or the other the stock refrain in MRTFP is: “The task ahead in order to continue the process of fiscal consolidation is admittedly more challenging, especially with regard to the elimination of revenue deficit.”

It is not all challenging if the Government shows the political will and shows some concern for the future generations.

The basic reason for complete failure to eliminate revenue deficit is to unwillingness to treat tax expenditure or tax preferences on the same footing as much-maligned subsidies.

The revenue foregone through tax preferences that primarily accrue to vocal & influential sections among the tax payers shot up from Rs 414,099 crore 2008-09 to Rs 502,299 crore in 2009-10. The latter figure is 79.54% of the aggregate tax collections in the same year. And it is 52.64% more than the revenue deficit of Rs 329,061 crore in 2009-10.

The Government has for years complicated the tax structure with innumerable tax concessions with mistaken belief that they ultimately result in investment-led creation of jobs and trickle down of wealth. Tax benefits primarily enrich the beneficiaries. They only distort investments from one sector to another and from one region to another.

As put by FC: “From the academic and policy literature on the subject and based on studies prepared for the Finance Commission, we are of the view that the impact of many central subsidies–including tax expenditures–is, on balance, regressive.”

Look FC has equated tax expenditures or concessions with subsidies. Can the Finance Ministry align its views on this matter with FC? The answer to this should be available in the finalized Direct Code and GST framework whose introduction has been deferred to next fiscal.

The Government can also make its task of eliminating revenue deficit less difficult simply by acting on FC's advice relating to disinvestment and sale of surplus land.

As for reducing revenue expenditure, the Government has hardly done much to reduce its expenditure on salaries and internal security including security for VIPs.

Had the Government unveiled voluntary retirement scheme for its employees at the start of economic reforms in early nineties, the revenue deficit would become zero long time back.

It also needs to do some innovative thinking to break the vicious circle of annual increase in the food procurement prices followed by annual increase in the food subsidy even in the years when there has been no increase in prices of agri-inputs. It also ought to set a definite timeframe for introduction of target-specific subsidies under the E-governance framework.

The Government should embrace binding commitments on revenue deficit. And these should be incorporated in FRMA and not the rules for the simple reason that it is easy tinker with rules and difficult to amend laws due to factors such as global meltdown.

It is here pertinent to quote FC. It says: “we recommend that the FRBMA specify the nature of shocks that would require a relaxation of FRBM targets. These would include agro-climatic events of a national (rather than regional or state-specific) dimension, global recessions impacting the country's exports and shocks caused by domestic or external events like asset price bubbles or systemic crises in important sectors like the financial markets. It is clear that these shocks would affect some targets more than others. Thus, shocks requiring a boost to aggregate demand, or sharp increases in global oil prices would require a temporary relaxation of the revenue deficit target.”

Like FC, International Monetary Fund (IMF) had also proposed tightening of fiscal law.

In its country report on India released in June 2009, it listed six “weaknesses” of FRBMA and its rules. These are: 1) Absence of clear accounting definitions for target fiscal indicators.2) Insufficient transparency in budget preparation. 3) Focus on a current balance target. 4) Lack of explicit debt and expenditure targets. 5) Absence of well-defined sanctions for noncompliance. 6) No independent assessment of compliance with the FRBMA.

It has proposed a slew of initiatives to make FRBMA an effective instrument of fiscal management. The proposals include: 1) “tighten the definition of escape clauses so that they only apply to exceptional circumstances and require objective analysis and scrutiny in their application by an independent fiscal council to strengthen credibility; 2)reduce the size of deviations that trigger corrective actions; 3) introduce automatic and time bound mechanisms to correct deviations from targets that prioritize areas of spending that would be cut if there were a need and 4) introduce explicit penalties that are applied automatically when fiscal targets are missed and/or budget procedures are not followed.

The best initiative would be repeal toothless FRBMA 2003 with one that binds the Government into eliminating revenue deficit. The Government currently enjoys absolute immunity for violation of this Act by virtue of the provision that reads as: “No suit, prosecution or other legal proceedings shall lie against the Central Government or any officer of the Central Government for anything which is in good faith done or intended to be done under this Act or the rules made thereunder.”

The Government had itself weakened FRBMA by shifting the targets for reduction of revenue and fiscal deficit from the original draft bill to the rules in the Act. This empowers the Government to amend the targets merely by informing Parliament.

Now that the opportunity to amend FRBMA has fallen due, it should act to prevent further indebtedness of coming generations. It should have the vision for the future.