Understatement is not a virtue

The UPA government has been claiming that it has done well on fiscal consolidation.

The UPA government has been claiming that it has done well on fiscal consolidation. But as always, there is a difference between appearance and reality. Off balance sheet items have meant effectively larger budget deficits than the magnitudes talked about in the discussion under the Fiscal Responsibility and Budget Management FRBM Act.

Budget 2008 will be keenly watched on how it deals with the deficit numbers. The real question is: will the UPA continue to obfuscate the truth by hiding behind technicalities and keep a huge part of its borrowing outside the ambit of FRBM? Or, will the finance minister show his commitment to fiscal consolidation by bringing in oil, food and fertiliser subsidies frontally into the deficit numbers and pave the way for the next stage of FRBM?

The 8216;gross fiscal deficit8217; of the central government is the borrowing that it does in the year. It measures the extent to which the central government lives beyond its means. This is normally expressed as a per cent of GDP, or the production of goods and services, of the country in the year.

As the figure shows, the 1980s saw a sharp increase in the problem. The worst value ever was 8.3 per cent in 1986-87. When Manmohan Singh became finance minister, a sharp reduction was obtained from 7.3 per cent in 1990-91 to 5.19 per cent in 1991-92. However, this was not followed through with further gains and the deficit stagnated at this level till 1994-95.

In the late 1990s, when the macroeconomic downturn came, tax revenues suffered and the deficit expanded all the way to 7.01 per cent in 1998-99. From this point, major progress has been apparently achieved with a decline to 3.3 estimated in 2007-08. The FRBM Act requires bringing this down to 3 per cent 8212; or roughly the value prevalent in the seventies.

It is highly desirable that the UPA achieve this target of 3 per cent, and thus set the stage for enactment of FRBM-II which will put India on a long-run sound fiscal foundation. However, the recent record of deficit reduction has been marred by a substantial extent of placing expenditures of the UPA 8216;off balance sheet8217;. Food, fertiliser and petroleum are subsidised by the government and affect its liabilities. The 8216;true gross fiscal deficit8217; is larger than the 8216;gross fiscal deficit8217; number stated in the budget document.

The latest IMF India country report estimates the impact of these off balance sheet items on the fiscal deficit. As the table shows, for example, without including these items, the fiscal deficit in 2006-07 was 3.5 per cent of GDP. However, including them, it was 4.5 per cent of GDP.

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In its report on the economy, the Prime Minister8217;s Economic Advisory has also noted that there are substantial off budget liabilities and this is not desirable. The bonds issued to oil companies to compensate them for the losses arising from increase in the international price of oil and inability of the government to increase the domestic prices of oil commensurately are part of the central government8217;s liabilities. In 2006/07 oil bonds issued amounted to Rs 19,150 crore. Securities issued to the Food Corporation of India in 2006/07 amounted to Rs 16,200 crore. Fertiliser subsidies also added to the government8217;s liabilities. The EAC estimated these add up to about 1.0-1.5 per cent of GDP. A Citibank report on the fiscal deficit had similar numbers.

In Budget at a Glance 2008-09, the summary statement of the budget, the finance minister should explicitly put out a consolidated number for the 8216;true gross fiscal deficit8217; in Rs crore and as a percentage of GDP the way he does for the 8216;gross fiscal deficit8217;. Since no one is really being fooled by the understated gross numbers, it will be better to be upfront about it and discuss the seriousness of the issue.

The writer is senior fellow, National Institute of Public Finance and Policy