Opinion The fiscal imperative

The FRBM Act — widely regarded as a landmark in India’s economic history — explicitly recognises that without an enduring commitment to fiscal discipline,no government can redeem the development mandate vested upon it by the people. The fiscal targets to be achieved by the state were enumerated in the rules framed under the legislation. These include,among others,progressive reduction in the fiscal deficit to 2.5 per cent of GDP and eliminating revenue deficit,and limiting the corpus of public debt and contingent liabilities to a specified proportion of the GDP. The table summarises the fiscal performance of the Union of India during 2004-2009.

Evidently,the FRBM Act has only been partly successful in attaining the intended targets. While public debt was contained,other core fiscal indicators — revenue deficit and fiscal deficit — actually worsened in the terminal year. The slippage in fiscal performance during the period under review occurred not so much due to a shortfall in revenues — the tax-GDP ratio was particularly buoyant in that period — but on account of increased expenditure commitments arising from the implementation of the Sixth Pay Commission’s recommendations,waiver of farm loans,three fiscal stimulus packages,etc.

Beyond the terminal year 2008-2009 and till date,the trends in core fiscal indicators continue to cause concern. While the revenue deficit is likely to increase from Rs 3,38,998 crore in 2009-2010 to Rs 3,94,951 crore (revised estimates 2011-2012),the fiscal deficit as percentage of GDP is expected to be marginally lower,from 6.4 per cent in 2009-2010 to 5.9 per cent (revised estimates 2011-2012). With the global economic slowdown showing no signs of abatement,fluctuating international crude and commodity prices,and high domestic inflation rates,there is an urgent need to take credible and effective steps to signal India’s continued commitment to reforms.

Any effective rule-based fiscal surveillance framework must incorporate targets that are comprehensive,difficult to override and enforceable with provisions for significant penalties in case of default. It is clear that the incentive structures designed in the FRBM Act lacked these attributes and thus,could not bind the state on the path of fiscal rectitude. A new fiscal rule — effective revenue deficit — has recently been introduced through an amendment to the FRBM Act,but has not evoked much enthusiasm.

India should consider adopting a more comprehensive “cyclically adjusted budget balance” as the rule to measure and monitor fiscal performance. This indicator measures the state’s fiscal position net of cyclical effects. The specific fiscal target could include attaining and maintaining “cyclically adjusted budget balance” by March 31,2016 and beyond. The introduction of “expenditure ceilings” in non-core/ non-development sectors,with emphasis on obtaining value for money,would also allow space for targeted fiscal expansion in priority sectors during times of need.

Fiscal responsibility has to be enforced to ensure that no political party free-rides on the fiscal discipline of others. To achieve this,a Fiscal Responsibility Council (FRC) headed by the prime minister,and comprising the finance minister and leaders of major political formations in Lok Sabha,has to be constituted. Its mandate could include assessing the soundness of assumptions underlying economic and fiscal policy planning,laying down an annual roadmap for the attainment of fiscal goals and monitoring progress,and evolving penalties on the government in case of default.

The budgeting practices in the Union government need to be improved in line with international best practices. The budget manual can be amended through an executive order to adopt a “top-down” approach to budgeting. Under this system,once the Union cabinet has approved the overall annual expenditure aggregates of each department,the power to decide on inter se allocation within a department would vest with the concerned minister. This would encourage every departmental minister to function as the department’s own finance minister and promote intensive intra-departmental programme scrutiny vis-à-vis intended outcomes.

The gaps between economic/ fiscal forecasts and the year-end actuals in India are worrisome. They constitute key risks that can derail fiscal consolidation and render budgeting into an exercise in futility. Like Canada and the Netherlands,India should adopt prudent margins in preparing key forecasts and also create a fund in the public account to defray costs arising from forecasting errors by setting aside,say,about 0.1 per cent of GDP each year. Similarly,the government should disclose the sources of revenues that would finance the supplementary estimates presented to Parliament each year.

Several countries across the world have coalition governments — the UK,Germany,Sweden,Finland and Canada,for example. These countries have institutionalised rule-based fiscal surveillance and monitoring systems that help government evolve political consensus on reforms modalities and foster results-oriented governance. Sweden,for instance,introduced expenditure ceilings (1997) and budget surplus target (2000) as measures for fiscal performance. With a fiercely independent fiscal responsibility council at the helm,Sweden’s expenditure ceilings have never been breached. The budget surplus target has served the country well during the global economic downturn.

The signs of fiscal distress in India are ominous. International credit rating agencies — Standards and Poor’s,and Fitch — have already scaled down the country’s credit outlook from stable to negative with the threat of a further downgrade to junk status if the fiscal situation does not improve. Comprehensive reforms are no longer a matter of choice but an inescapable compulsion. Will the executive and Parliament in India rise to meet the fiscal challenges facing the country?

The writer,an IAS officer of 1997 batch (Tamil Nadu cadre),is currently Deputy Director (Sr) at the Lal Bahadur Shastri National Academy of Administration,Mussoorie. Views are personal