JANUARY 24, 2014

By Naresh Minocha, Our Consulting Editor

PRESENTING the 2013-14 budget, Finance Minister P. Chidambaram stated: "In September, 2012, Government accepted the main recommendations of the Dr. Vijay Kelkar Committee. A new fiscal consolidation path was announced. Red lines were drawn for the fiscal deficit at 5.3 percent of GDP this year and 4.8 percent of GDP in 2013-14. I know there is a lot of scepticism."

Yes, Mr. Chidambaram, the well-justified skepticism is now transforming into derision with the Government trying both new and old tricks to prove that FM's red line on fiscal deficit for 2013-14 has been respected.

With the firing of all cylinders from the accounting tricks & jugad domain, it would be hardly be surprising if FM manages to adhere to budgeted deficit in the interim budget for 2014-15. Mr. Chidambaram is bound to leave a lot of unaccounted or under-estimated fiscal liabilities to his successor who in all probability would be a non-congress, non-UPA person.

As put by CRISIL in its 'India Economic Forecast- No fireworks in 2014-15', "rollover of diesel and fertilizer subsidies from the current fiscal year will limit the downside to overall subsidies. Food Security Bill, if rolled out across several states, could further inflate the subsidy outgo of the government."

Add to this the prospects of increasing the number of subsidized LPG cylinders to 12 from nine following a clarion call given by Mr. Rahul Gandhi at the recently held meeting of All India Congress Committee.

Factor in also the severe fiscal pressure that would be borne by the Centre and later by the States after 1 January 2016, the date for implementation of recommendations of the 7th Pay Commission (PC) set by FM in September 2013.

The Union Cabinet is expected to approve shortly the terms of reference for the proposed PC. Why the Government can't take a break from the tradition of Government setting up PCs once in a decade? Why has it not instead set up a commission for countless, exploited outsourced workers including scientists?

As the 14th Finance Commission (FC) is required to submit its report by October 2014, it can't estimate the impact of PC's award on fiscal and revenue deficit that it would recommend for the Centre and the States.

Fiscal pundits know that the red lines drawn by the 13th Finance Commission have already been breached. And the colour of lines embedded in Fiscal Responsibility and Budget Management Act (FRBMA), 2003 has been changed to green in the past. The statutory management of fiscal deficit and revenue deficit has become the most ridiculous initiative in India.

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.The 13th FC fixed a revised target of zero revenue deficit for 2013-14. The Finance Minister, on other hand, opted for revenue deficit of 3.3% of GDP for 2013-14. The revenue deficit for April-November 2013, however, amounted to 103.5% of the budget target, according to latest fiscal data released by Controller General of Accounts on 31 st December 2013.

FM has proposed a revenue deficit target of 1.5% for 2016-17, a task that may become impossible to achieve due to implementation of right to food law and recommendations of the proposed PC.

Before discussing a new road-map for fiscal reforms including amendment of FRBMA, a recapitulation of tricks involved in fiscal management would be meaningful.

An Old trick is to roll over or spill over the subsidy bills to next year, which has become a compulsive fiscal disorder ever since Dr. Manmohan Singh rationalized this as “normal commercial practice” in his 1992-93 budget speech.

With subsidy arrears becoming unbearable for fertilizer and oil marketing companies, the Finance Ministry has contrived the practice of issuing comfort letters that come with or without loans to help them do window-dressing of accounts and somewhat ease liquidity crisis.

A comfort letter facilitating bank loans to the companies is called special banking arrangement (SBA). On 22 nd January, The Department of Fertilizers (DOF) unveiled FM-approved Rs 9000-crore SBA to permit the fertilizer companies to raise short term loans through two banking consortia against the subsidy receivables. Why has RBI maintained silence on SBA?

The two consortia will charge interest rate of 10.40 percent on these quasi-government borrowings to be given to firms against fertilizer subsidy receipts. The Government's liability towards interest on the loans would be limited to G-sec interest rate of 8% per annum. The remaining interest over and above this G-sec interest rate would be borne by the companies.

DOF would repay the loan after allocation of funds for subsidy in the budget estimate for 2014-15.

An SBA for Rs 5500-crore subsidy was provided earlier in the current fiscal and for Rs 5000 crore in the last quarter of 2012-13. SBA, an off-budget transaction, has thus the potential of succeeding the dubious special securities (oil and fertilizer bonds) that touched dizzy heights, forcing FM to seek guidance on bonds from 13th FC.

Another old trick that is being considered to manage fiscal deficit is to ask ONGC and OIL to buy equity stakes in IOC. This is reminiscent of the cross-holdings that FM engineered among IOC, ONGC and GAIL in February-March 1999 to check its fiscal deficit. These companies had then bought the shares of each other from the Government under the garb of strategic investments.

Yet another time-test technique to shore up non-tax revenue is to prod public enterprises including nationalized banks to give interim/higher dividends.

A CRISIL release dated 23 rd December 2013 reckons: "the Centre can reduce its fiscal deficit by as much as Rs 20,000 crore this fiscal by using cash reserves of public sector units (PSUs)."

Another ploy used to make net tax receipts appear robust is to solicit higher advance tax and defer refunds to the next year. The issue of refund of excess taxes paid has already been dealt at length by Public Accounts Committee in its report submitted in August last year.

It is here pertinent to quote a Business Standard story datelined 15th January 2014 says: "Tax officers are reportedly asking companies to make higher advance tax payments and, if their actual profits turn out to be lower than projections, take refunds next year. If refunds are high, this would mean an extra burden on the next government, as the finance ministry pays interest at 0.5 per cent per month, or six per cent a year, on refunds to taxpayers. For companies, this means the money that could have been invested elsewhere lies idle."

In the absence of independent monitoring of the Government's compliance with fiscal discipline and translucent nature of fiscal transactions, the public criticism right from enactment of FRBMA legislation is totally justified.

It is a lame-duck law that is maiming subsidy-choked sectors fertilizer, oil & gas and food procurement and storage sectors. FRBMA should be amended to prevent roll-over of unpaid, overdue government bills to the next year. A fool-proof mechanism is required on this front to prevent transmission of fiscal sickness into industrial sickness.

Alternatively, the Government must stop using the industries as conduit for payment of subsidies and pay cash directly to the targeted beneficiaries including diesel and fertilizer consumers.

Hear from the horse's mouth. The Fertiliser Association of India (FAI) says: "The unpaid subsidy bills carried forward from the year 2011-12 to 2012-13 amounted to more than Rs.22,000 crore. Similarly, the backlog of 2012-13 carried forward to the year 2013-14 is estimated at about Rs.32,000 crore. Such outstandings seriously impact the cash flow of the fertiliser industry crippling their ability to continue production, import and supply of fertilisers. Industry has to arrange additional working capital to fill gap created by delayed subsidy payments. This results in additional interest cost which is not recognized underpricing and subsidy schemes. Sometimes, companies are not able to get additional line of credit and even if they get it, it comes at higher interest rate than the normal line of credit. The impact of interest cost on pending subsidy bills of the order of Rs.32,000 crore comes to about Rs.1600 crore at a conservative interest rate of 10% per annum if the amount remains pending for six months. The Government has been rolling over these pending subsidies from one year to the next for the last few years with the amount increasing every year in view of the tight fiscal situation of the country. The interest burden of such dues on the industry has become unsustainable."

Let us again revert back to the forgotten fiscal road map. Explaining the action taken on the recommendations made by the 13th Finance Commission (FC) on 25th February 2010, the then Finance Minister, Pranab Mukherjee stated: "For Centre, it has recommended RD (revenue deficit) to be eliminated and FD (fiscal deficit) to be brought down to 3% of GDP by 2013-14."

He added: "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."

In its report submitted in December 2009, FC recommended that public private partnership (PPP) liabilities should be reported along with the Medium Term Fiscal Policy (MTFP). PPP liabilities do not figure in MTFP or two other documents, Fiscal Policy Strategy Statement and Macro-Economic Framework Statement that presented under FRBM framework as part of Budget documents. PPP liabilities also find no mention in a post-budget document captioned Medium Term Expenditure Framework (MTEF).

FC's another unimplemented recommendations is that the Government should list all public sector enterprises that yield a lower rate of return on assets than a norm to be decided by an expert committee.

It also suggested that The FRBM Act specify the nature of shocks that would require a relaxation of FRBM targets. This has not yet been done.

FC recommended setting up of an independent review to evaluate its fiscal reform process. The independent review mechanism should later develop into a Fiscal Council with legislative backing over time.

Fiscal Councils have been set up several countries. The Irish Fiscal Advisory Council, for instance, independently assess whether the Government is meeting its own stated budgetary targets and objectives. It assesses the appropriateness and soundness of the Government's macroeconomic projections, budgetary projections and fiscal stance. The Council also examines the extent of Government compliance with legislated fiscal rules.

Why has Mr. Chidambaram not spoken about UPA's failure to implement fiscal road map laid down by 13th FC? This question assumes special significance when viewed against FM's own admission that FRBMA is too flexible.

According to an Economic Times story dated 13th November 2013, Mr. Chidambaram said the fiscal deficit, current account deficit (CAD), central bank's mandate and inflation target shouldn't be subject to executive discretion to ensure responsible economic policies.

The story quoted him as saying "Some things must be set in stone... fiscal deficit, current account deficit, mandate to RBI, inflation target... These must be put beyond the discretion of any government."

Now that fiscal discipline is caving in under the weight of populism, would he, as an outgoing FM, not seize the opportunity to propose fiscal reforms that should be cast in stone?