Opinion The living debt

The increase in the fiscal deficit since Budget 2009 has,however,not been absorbed that quietly. There has been a sharp and steady increase in the yields on government bonds. Bond-holders,including now even the captive public sector banks,demand a larger premium for holding more government bonds. There can be a long debate about the extent to which this could hurt private investment,and this debate is unlikely to be conclusive. But what there can be little disagreement about is that larger interest rates today mean larger interest payments tomorrow. This is not to say that no growth enhancing infrastructural investments can be made by the government. But that the level of borrowing today has to take into account future growth rates and interest rates to arrive at sustainable debt/ deficit numbers. Today,with rising interest rates on government bonds,the need for the government’s commitment to fiscal consolidation is more urgent than ever.

The inadequacies in the Fiscal Responsibility and Budgetary Management Act (FRBM) became apparent with the rise in oil prices that created a large off-budget deficit. Following that,the Sixth Pay Commission,farmer debt waiver and social sector spending like the NREGA,ended all semblance of fiscal consolidation. The cut in taxes following the global crisis added to the deficit. Despite the high growth rate witnessed over the last decade,the ratios of fiscal deficit to GDP and debt to GDP rose sharply.

The Thirteenth Finance Commission was given the task of recommending a revised roadmap for fiscal consolidation,or an FRBM-II. Among its recommendations the commission suggested a target for the debt-GDP ratio: a combined level of 68 per cent for Centre and states. This level was 82 per cent in 2008-09. This means that today’s level of debt is not sustainable. Reaching the sustainable target will require a reduction in borrowing by both Centre and states. An essential element of the roadmap for consolidation includes a golden rule,under which no one should borrow for current expenditure. This translates into a zero revenue deficit and a 3 per cent fiscal deficit by 2013-14.

The process by which these would be achieved is envisaged to be a significant improvement over how the first FRBM was done. The commission recommends,first,that there needs to be much greater transparency and detail to make the FRBM effective. A medium-term fiscal plan should be put in place containing three-year ahead detailed estimates of revenues and expenditures with explanations of how these estimates were arrived at. Recommendations on how to make the fiscal consolidation process transparent include spelling out contingent liabilities of public-private partnerships,revenue consequences of capital expenditures,separate statements of Central transfers to states,reporting of compliance costs of major tax proposals,moving all disinvestment receipts to the consolidated fund of India to enable the use of these funds as part of the medium-term fiscal planning exercise and the maintenance of inventories (at market prices) of land and building held by government departments.

The second significant change in the FRBM is recommended to be sensitivity to business cycles. In the present downturn,the path of fiscal correction was reversed when the government undertook measures to provide a fiscal stimulus. While this was done in an ad hoc manner,the commission has recommended that the medium-term fiscal policy should lay down rules for relaxation of fiscal targets. It should specify the bands within which fiscal targets can be changed. Counter-cyclical fiscal policy is needed sometimes,but it should not put an end to the path of fiscal correction.

Finally,the commission has recommended independent review and monitoring of the implementation of the FRBM. Committees for such review have been set up in the past by some state governments and should now be set up by the Centre. There should be a Fiscal Council that acts as an autonomous body reporting to the finance ministry,which should report to Parliament. The role of such an institution will become more important as the size and complexity of the Indian economy evolves. It should help the government in a transparent and professional manner. Countries such as Brazil,Japan,Korea,Mexico and Sweden have such institutions. In today’s environment of high public debt and rising deficits,such an institution can play an important role not only in assisting the government in the task of fiscal consolidation,but it can also add integrity to the government’s medium-term plans for fiscal consolidation.

Moving away from the one-size-fits-all path of fiscal consolidation recommended for states earlier,the recommendations differ according to the growth and fiscal condition of each state. This would work towards preventing contractionary fiscal consolidation in states. A suitable path to consolidation,combined with state-level fiscal councils,would help in achieving the goal of reducing the state debt to 25 per cent of GDP over five years.

The writer is a professor at the National Institute of Public