The Hindu Business Line : Terrorism, meltdown and fiscal chastity

India must fight the wars on terrorism and financial meltdown, effectively and expeditiously. The government needs to undertake selective and focused pump-priming and generalised payouts should be avoided, says S. S. TARAPORE.

Let there be no mistake about it. India is a country at war — a war on terrorism and a war dealing with the global financial meltdown. These wars have to be fought effectively and expeditiously and there are unavoidable costs as also collateral damages. At the control room of these insidious wars is the Indian fisc. If we are to maintain strict fiscal rectitude, the country may face serious damage and if we resort to skilled financial engineering to skirt around the costs, we would lose the other vital war against inflation. There are no soft options.

Financial costs

The war on terrorism has to be fought without any cringing on the financial costs. The expenditure on countering terrorism should not be kept on a tight leash, though there should no doubt be proper accountability, Let us not believe that a few coppers would suffice.

This is priority No.1 today and we should be prepared to meet whatever cost it takes to effectively combat terrorism. The costs of an effective response could be colossal and while earmarking is not a good principle in public finance, there should be a special tax/cess earmarked for this purpose; the citizens of this country would be willing to bear this burden. The words of Bob Dylan would surely ring in our ears:

“Yes ‘ n’ how many deaths will it take till he knows

That too many people have died.”

The backwash effect of the global meltdown on the Indian economy would be lagged and long drawn out. Monetary policy is not an efficient tool for handling such emergencies. The appropriate instrument is fiscal policy: Fiscal surpluses must be built up during the upturn of the cycle and fiscal deficits resorted to during the downturn. In the Indian case, however, there are large fiscal deficits at all times, irrespective of the stage of the cycle and this poses a constraint when an expansionary fiscal policy is warranted.

It has been “Such a Long Journey” as Rohinton Mistry would put it, from Dr C. Rangarajan’s Indian Economic Association Presidential Address in 1988, calling for an Accord between government and the RBI, followed by the two Supplemental Agreements between the RBI and government in 1994 and 1997; the E. A. S. Sarma-Y. V. Reddy Report in 2001 and, finally, the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.

Under this Act, the revenue deficit was to be wiped out and the gross fiscal deficit (GFD) reduced to 3 per cent of GDP; this target has been successively moved forward to March 2010. Furthermore, RBI’s support to the market borrowing of the government was also phased out.

Surplus to deficit

While there is a general perception that a revenue deficit was all along part of the system for the past 60 years, it bears mentioning that up to 1978-79, there was a revenue surplus. There should be a reversion to the earlier practice of a small revenue surplus. It would appear that, in 2008-09, fiscal expenditures are lurching out of control. In the current financial year, up to October 2008, the revenue deficit was 57.7 per cent above the full year’s target, while the gross fiscal deficit (GFD) was already 87.8 per cent of the full year budget estimate.

What is more alarming is that the quasi fiscal deficit (the deficit kept outside the budget) in the current financial year has been estimated at 5 per cent of GDP and even if it is eventually lower because of the reduction in the international crude oil price, the overall GFD, in effective terms, would be way above the 3 per cent envisaged in the FRBM.

Fiscal stimulus

All signs point to an economic slump in the industrial countries. Paul Krugman calls it a “nasty brutish and long” recession which could be a euphemism for the forbidden dirty word “depression”.

While in countries where there is reasonable monetary-fiscal control, it makes sense to undertake a large fiscal stimulus, in India, there is a dilemma in that the fisc has been out of control even before the global financial meltdown. The global meltdown would impact India in two ways. First, the international slowdown would inevitably impact exports. Second, a number of industries and financial institutions are fragile and need some fiscal relief.

There are vocal advocates for a large and quick fiscal stimulus but this would have a crowding-out effect. In some ways, the government is damned if it did and damned if it does not. What should the authorities do? The government needs to undertake selective and focused pump-priming; generalised payouts should be avoided.

There is talk about a large fiscal stimulus akin to that in the industrial countries. There is, however, a major difference. The industrial countries have witnessed a recession (defined as two successive quarters of negative growth). In contrast, the most pessimistic estimates of growth in India is 7 per cent in 2008-09 and 6 per cent in 2009-10. Thus, it is not feasible for India to ape the industrial countries and undertake a large fiscal stimulus to deal with the fallout of the financial meltdown in the industrial countries.

India’s dilemma

Furthermore, in India, we face two separate problems. One, the war on terrorism could conceivably require large outlays of expenditure. While it is difficult to put any precise number to this requirement, whatever be it, the nation cannot afford to stint on providing the necessary resources. Two, the global meltdown should not be an excuse for acceding to the general clamour for subventions; nonetheless, a select fiscal stimulus may be necessary.

How should the total additional expenditure be financed? First, there should be an across-the-board Security Tax Surcharge on all taxes — direct and indirect. Second, there should be a carefully crafted reduction in the plethora of exemptions for both individuals and corporates.

Third, any reduction in the petroleum prices should be deferred for the time being. Fourth, subsidies should be gradually reduced. Fifth, an increase in the borrowing programme may be necessary and this would entail higher costs of borrowing. Sixth, there should be no further monetary stimulus at this stage.

Per contra, there may be a need for some balancing assistance on a select basis for sectors affected by the global financial meltdown. Again, to the extent some investment is deemed necessary, the government should undertake labour-intensive projects with substantial backward and forward linkages.

There are some intemperate thoughts being floated suggesting that the RBI balance-sheet should be made part of the Consolidated Fund of India. While this would be a disastrous gimmick to cover the fiscal deficit, it is a serious matter and needs separate treatment.

It would be imprudent to relax or abrogate the FRBM. To quote Dr Isher Ahluwalia, “The FRBM is like a chastity belt, don’t loosen it without a better alternative”.

(The author is an economist. blfeedback@thehindu.co.in)

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