The Hindu Business Line : Planners fret at fiscal constraints

The Planning Commission's Eleventh Plan Approach Paper favours shifting the FRBM requirements so that fiscal deficit targets are not absolute, but are cyclically adjusted in keeping with international practices. The Approach Paper also takes issue with the fiscal reformers on reduction of revenue deficit, a complex task.

The Planning Commission's Approach Paper on the Eleventh Plan focusses attention on faster and more inclusive growth. Contrary to public perceptions about our planners, they have come out openly in favour of a greater role for the state, that is, the Government, and the public sector in providing for the necessary investments and growth in services.

The Planning Commission has caught the mood of the political establishment in favour of a greater and more aggressive role for the state in infrastructure, though it acknowledges the importance of public-private partnerships.

Overall, however, it is the mixture as before, but has a clear direction in favour of outcome, efficiency and regional equity.

Particularly striking is a clear statement by the planners in favour of considering the option of shifting the FRBM (Fiscal Responsibility and Budget Management) targets for reduction of fiscal deficit by two years. It puts forward the idea of modifying the rules under the FRBM Act so that fiscal deficit targets are not specified in absolute terms, but are cyclically adjusted in keeping with international practices in this regard.

Unfortunately, says the Approach Paper, these options may not be available for the States, which may face similar problems. The Plan's needed investments cannot be accommodated if we follow the FRBM's restriction on fiscal deficit.

The planners have come out with the clear recommendation that the FRBM targets themselves may be altered to make possible the achievement of the Plan targets. The Palnning Commission Deputy Chairman, Dr Montek Ahluwalia, is on the side of pragmatists and recognises the infeasibility of rigid fiscal deficit targets.

On revenue deficit

The Approach Paper has yet another serious difference with fiscal reformers, in that the zero revenue deficit in FRBM is difficult to achieve because of the shift in Plan expenditures towards social sectors.

A large proportion of the expenditure undertaken is treated as revenue expenditure, even though it may be used to build assets as, for instance, in Bharat Nirman, Employment Guarantee, the Jawaharlal Nehru Urban Renewal Programme and all new schemes of the National Horticultural Mission. They are, in effect, grants to implementing agencies in the States.

A similar problem arises on viability gap financing, which is clearly linked to investments under the Scheme but is classified as a revenue item. All this suggests, says the Approach Paper, that it may not be easy for the Centre to reduce the revenue deficit from 2.1 per cent in 2006-07 to 0 per cent by 2008-09, while simultaneously achieving large increases in Plan expenditure with a high revenue component.

The Approach Paper is clear in its warning: "The thrust of the approach presented in this Paper, which involves innovative financing of infrastructure with a massive decentralised thrust in health and agriculture, may be defeated if the FRBM discipline is insisted upon with the current definition of revenue deficit".

The States may also face a problem as the limit on the size of the revenue deficit will restrict the extent of and pace of devolution to the Panchayat Raj institution — a setback to the approach being advocated in the Paper.

The planners objected to the very concept of revenue deficit as a fiscal control means and point out that revenue deficit is not internationally recognised as a relevant concept. I quote the Paper: "Internationally, fiscal responsibility legislation focus on, in addition to fiscal deficit, primary deficit (which is fiscal deficit minus interest costs) as the relevant control variables. The case for focusing on the primary deficit is that interest costs on accumulated debt, which are outside the scope of government control may vary with interest rate changes, which do not reflect the quality of fiscal control. In fact, international practice recognises need for counter-cyclical policy and therefore focuses on cyclically adjusted fiscal deficit." Then comes the clincher. "There is a case for amending our FRBM legislation to conform to international practice".

Planners vs reformers

The conflict between planners and fiscal reformers could not have been put more sharply. Obviously, the targets laid down in the FRBM legislation have been predicated on too high an order of tax effort, including tax reform and containment of non-Plan expenditure. One can easily forecast what the outcome of the controversy will be.

The planners normally win. Fiscal reform has to take the back-seat, given the compulsions of planners, which reflect the National Common Minimum Programme, ambitious infrastructure spending and investments for bridging regional inequality.

Dr Montek Ahluwalia has chosen the right opportunity to strike a blow for pragmatic fiscal reform that recognises the need for a large Plan. But will the Finance Minister be able to adjust his "ideological" support for fiscal reforms to the prevailing winds in favour of larger Plan outlays? If the FRBM Act stays unamended, the Plan has to be trimmed. Obviously, the FRBM Act has to be trimmed!

The EU experience

This problem is not unique to India. Those who have followed the Maastricht targets and their non-performance will recognise a close parallel between the EU experience and ours. One of the reasons the UK kept out of the EU was the imposition of a strict fiscal deficit standard of 3 per cent of GDP.

Mr Gordon Brown, the UK's Chancellor of the Exchequer, suggested that fiscal deficit should be restricted to deficit incurred for creation of assets. That is, current outlays should not be financed by fiscal deficit. In any event, the purists won the debate in the EU and fiscal deficit was enshrined in the EU Constitution. The problem, however, arose with Germany and Italy, even France, not being able to meet the targets.

Those failing the targets were to be subjected to hefty fines to be imposed by the Brussels bureaucracy. There was some tampering with the goalposts and the offending countries were effectively let off without fines being paid.

The moral of the story is that rigid fiscal deficit targets are difficult to implement, even in mature economies such as the EU. Much more so will be the difficulty faced by a developing country like India.

Initiate discussion

Lest this controversy clouds the formulation of the Plan, it would be the path of wisdom for the Prime Minister to intervene and organise a conference to sort out the issues between the planners and finance.

As a former Deputy Chairman of the Planning Commission, he is familiar with the problems. He had raised the issue of the size of the Plan when Rajiv Gandhi was Prime Minister.

Ultimately, it ended with Rajiv Gandhi himself adjudicating the difference by fixing the size of deficit financing, that is, fiscal deficit, at a hefty figure, unconstrained as he was by the shackles of an FRBM Act, which came into effect only in 2003.

"Fiscal deficit" reduction was a concept popular with IMF and IBRD economists. It was recommended to countries which resorted to massive external borrowing and got into trouble to bridge fiscal deficit. Perhaps, the situation is different when a country, such as India, does not need to borrow abroad to fund its needs.

While it is a healthy tradition to restrict fiscal deficit, particularly the revenue deficit component, the actual implementation is, however, a complex task.

Ultimately, the solution will have to be found by the good doctor, Dr Manmohan Singh, the progenitor of both the economic and fiscal reforms.