Indian Economy, 5th edition (85 page)

(iv)
The governments have failed on both the fronts—checking population rise and mass employment generation—the burden of different
subsidies
went on increasing making them unmanageable and highly illogical. Self-employment programmes could not pick up, or better said, it was politically suitable to go for piece-meal wage-employment programmes with different names.

(v)
Planned development remained highly centralised and devoid of any place for local aspirations—frustrations of masses started showing up in the form extremist and radical organisations raising their heads creating a law and order problem and excessive expenditure on them. The outcome was a burdened police force and lagging judicial set up.

(vi)
The plan expenditure which governments were going for were through investments in the PSUs which were not committed to profit motive, deficit financing for the PSUs was not based on sound economics. Majority of the plan expenditure in a sense turned out to be non-economic, i.e., non-plan expenditure at the end.

Due to the above-given reasons, it was tough to say whether it was sound to go for huge fiscal deficits in India.
29

The Third Phase (1991 onwards)

This started with the initiation of the economic reforms process under the conditionalities put forth by the IMF (controlling fiscal deficit was one amongst them). As the economy moved from government dominance to market dominance, things needed a restructuring and public finance also needed a touch of rationality. Till date, the government had been doing pure politics with the public money in the name of development. Now the IMF dictated and the economy headed towards greater and greater fiscal responsibility in the coming times. India is better today in this regard but we cannot say that public finance is based today on the sound principles of economics. But the rigorous process of fiscal reforms aiming at fiscal consolidation started in India.

Indian Fiscal Situation:
A Summary

In December 1985, the Government of India presented a discussion paper in the Parliament titled ‘Long-term Fiscal Policy’. It was for the
first time
in the fiscal history of India that we see a long-term perspective coming on the fiscal issue from the government. This also included the policy of government expenditure. The paper was bold enough to recognise the deterioration in India’s fiscal position and accepted it among the most important challenges of the eighties—the paper set specific targets and policies to set the things right. This paper was followed by a country-wide debate on the issue and it was in 1987 that the government came ahead with
two
bold steps in the direction—

(i)
a virtual freeze was announced on government expenditure, and

(ii)
a ceiling on the budgetary deficit.

The above steps had a positive impact on the situation but it was temporary as since mid-1988 the situation again started deteriorating. The BoP crisis at the end of 1990 was generated partly by the alarmingly high
fiscal deficit
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and due to a high level of external borrowings. The IMF support to fight the crisis came in but with many macro-economic conditionalities, checking the fiscal meance being a major one among them. With the process of economic reforms which started in 1991–92, the government also announced its comitment to reduce fiscal deficit to 3–4 per cent (of GDP) by the mid-1990s (from the level of about 8 per cent during 1987–90). This step was among the many measures which the government started with the objective of stabilising the economy. We may have a look at India’s fiscal situation upto the 1990–91 in the following way:

(i)
The fiscal deficits of the central government, after averaging below 4 per cent of GDP till the 1970s started climbing up by being 5.77 per cent in 1980–81, 8.47 per cent in 1986–87 ending up at 7.85 per cent in 1990–91 after being above 7 per cent in the second half of the 1980s.
31

(ii)
The revenue (i.e., current) expenditure of the government (Centre and states combined) increased from 11.8 per cent of GDP to 23 per cent between 1960 and 1990. The revenue receipts of the government also went up on an average of 14.6 per cent in 1971–75 to 20 per cent in 1986–1990. But the gap between revenue receipts and expenditures remained negative—financed largely by domestic borrowings (as a result the interest payments on domestic debt increased from 0.5 to 2.5 per cent of GDP during 1975–90.
32
The revenue deficit went on increasing after 1979–80 and reached the highest level of 3.26 per cent of the GDP in 1990–91.
33

(iii)
The fiscal situation of the states was not good either. State governments which are primarily responsible for health, education and other social services had an aggregate revenue expenditure of 5 per cent of GDP on these accounts while their capital expenditure accounted for 2.5 per cent on social and other sectors.
34
The states’ expenditure on social sector went down while their interest payments had increased during the 1980s.
35

As per the experts, the debt situation in the states would have been even worse, but for the fact that the states, unlike the centre, did not have independent powers to borrow either from the RBI or the market because of the statutory overdraft regulatory scheme.
36
Thus, their deficits have been self-limiting—whenever the states tried to cut down their deficits the care of social sector and capital expenditure suffered and development prospects in the states also suffered.

Now the question arises that why the government has not been able to check the menace of fiscal deficits even though there has been a consensus to do so?
There are reasons
37
which can be cited for it:

(i)
Political factor:
The political lobbies and sectional politics as well as the subsidies are supposed to be one big factor for rising government expenditure. We see this on a higher scale if there is a probable mid-term election or closer to a general election.

(ii)
Institutional factor:
The administrative size combined with the processes of reporting, accounting, supervising and monitoring getting greater importance than the production and delivery of goods and services.
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(iii)
Ethical factor:
This is a more powerful factor as it easily generates wide public support for the government expenditure. There are many heads of such expenditures such as subsidies (food, power, fertiliser, irrigation, etc.) poverty alleviation programmes, employment generation programmes, education, health and social services. The logic for such expenditure comes from the idea that the government should function as protector of the poor and provider of jobs for them implying that such government expenditures benefit the poor.

It was in 2000 that the double menace of revenue and fiscal deficits got attention from the government at the centre and some constitutional/statutory safeguards looked necessary. Consequently, the Fiscal Responsibility and Budget Management Bill, 2000 was proposed in the parliament.

FRBM Act, 2003

The fiscal policy of an economy has been considered as the building block for enabling macro-environment by the economists, policymakers and the IMF, alike. It does not only provide stability and predictability to the policy regime but also ensures that national resources are allocated in terms of their defined priorities through the tax transfer mechanism.

Unproductive government expenditures, tax distortions and high deficits are considered to have constrained the Indian economy from realising its full growth potential. At the begining of the fiscal reforms in 1991, the fiscal imbalance was identified as the
root cause
of the twin problems of inflation and the difficult balance of payments (BoPs) position.
39
Since then the
medium-term fiscal policy stance
of the government has been on the following lines:
40

(i)
reducing the deficits (revenue and fiscal);

(ii)
prioritising expenditure and ensuring that these resulted in intended outcomes; and

(iii)
augumenting resources by widening tax base and improving tax-compliance while maintaining moderate rates.

The fiscal consolidation which followed in 1991 failed to give the desired results as there was no defined mandate for it. Neither was there any statutory obligation to do so.
41
This is why the Fiscal Reforms and Budget Management Act (FRBMA) was enacted on August 26, 2003 to provide the support of a strong institutional/statutory mechanism. Designed for the purpose of medium-term management of the fiscal deficit, the FRBMA came into effect on July 5, 2004.

The FRBM Bill, 2000 was passed by the Parliament with all political parties voting in favour, and is considered a watershed in the area of fiscal reforms in the country. Main highlights of the FRBMA, 2003 are as given below:
42

(i)
GoI to take measures to reduce fiscal and revenue deficit so as to eliminate revenue deficit by March 31, 2008 (which was revised by the UPA Government to March 31, 2009) and thereafter build up adequate
revenue surplus.

(ii)
Rules to be made under the Act to specify
annual targets
for the reduction of fiscal deficit (FD) and revenue deficit (RD) contingent liabilities and total liabilities (
RD to be cut by 0.5 per cent per annum and FD by 0.3 per cent p.a.
).

(iii)
FD and RD may exceed the targets only on the grounds such as national security, calamity or on exceptional grounds.

(iv)
GoI not to borrow from RBI except by Ways and Means Advances (WMAs).

(v)
RBI not to subscribe to the primary issue of the GoI securities from 2006-07 (it means that these government bonds/papers will become market—based instrument to raise long-term funds by the government).

(vi)
Steps to be taken to ensure greater transparency in fiscal operations.

(vii)
Along with the Budget and Demands for Grants, the GoI to lay the following
three statements
before the Parliament in each financial year:

(a)
Fiscal Policy Strategy Statement (FPSS);

(b)
Medium Term Fiscal Policy Statement (MTFPS); and

(c)
Macroeconomic Framework Statement (MFS).

(viii)
The Finance Minister to make
quarterly review
of trends in receipts and expenditure in relation to the Budget and place the review before the Parliament.

Follow-up to the FRBMA

The process of fiscal consolidation under FRBMA has been continuous and essentially an incremental one. Some of the important fiscal measures
43
that are being implemented by the government are as given below:

(i)
reducing the peak rates of custom duties;

(ii)
rectifying anomalies like
inverted duty structure;

(iii)
rationalising excise duties with a movement towards a
medium CENVAT rate;

(iv)
revisiting the tax
exemptions;

(v)
relying on voluntary tax compliance through taxpayer
facilitation;

(vi)
introduction of State-level VAT for achieving a
non-cascading, self-enforcing,
and
harmonised
commodity tax regime;

(vii)
increasing productivity of expenditure through an
outcome budget
framework (which seeks to translate outlays into better outcomes through monitorable performance indicators);

(viii)
innovative financing mechanism like creation of Special Purpose Vehicle (SPV) for infrastructure projects; and

(ix)
states have also joined the process of fiscal consolidation in line with the Twelfth Finance Commission’s (TFC) recommendations and are complementing the efforts of the Central Government.

In 2006–07, in case of the
Central government,
proposed reduction in revenue and fiscal deficits were put at 0.6 per cent and 0.5 per cent, respectively (higher than the FRBMA Rules), though the reduction suffered in 2005–06 due to higher devolution to states by centre on account of the TFC recommedations.
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States
also showed considerable improvement (in fact, even better then the central government). The fiscal deficit of the states declined by 1.6 per cent post FRBMA from 4.5 per cent in 2003–04 to 2.6 per cent in 2006–07 of their GDP. Revenue deficit, on an aggregate basis, was budgeted to get eliminated by 2006–07, two years ahead of the target. (
A strong incentive-based restructuring scheme of fiscal transfers to states suggested by the TFC appears to have succeeded
.)
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Limiting Government
Expenditure

Elected governments are composed of different interest groups and lobbies. At times, such governments might intend to use its economic policies in a highly populist way for greater political mileage without caring for the national exchequer. Such acts might force the governments to go in for excessive internal and external borrowing and printing of currency. Governments generally avoid to increase tax or impose new taxes for their revenue increase as such acts are politically unpopular. On the other hand, borrowings and printing of currency impose no immediate economic or political costs. A government in the election-year usually spends money frugally by borrowings (from the RBI in India) because it is the coming government after the elections who is supposed to repay them. Government expenditures remain higher and expanding due to some economic reasons also—by doing so extra employment is generated and the output (GDP) of the economy is also boosted. If governments go for anti-expansionary fiscal and monetary policies with the objective of reducing its expenditures the employment as well as the GDP both will be hampered. This is considered a
bias
in the economic policies of the elected governments. But there has always been a consensus among the experts and policymakers that an external (i.e., outside the government) and some form of a statutory check must be over the government on its powers of money creation (i.e., by borrowings or printing). With the objective of removing the bias—to make fiscal policy less sensitive to electoral considerations, several countries had introduced some legal provisions on their governments before India enacted its FRBMA. We see mainly
three variants
of it around the world: