The Hindu Business Line : Is the economy losing the deficit war?

The Finance Ministry's Mid-Year Review 2006-07, released in Parliament on the penultimate day of the winter session, camouflages well the failure of the government to stick to key deficit indicators. But it does claim to conform to the FRBM (Fiscal Responsibility and Budget Management) Act requirements through "careful expenditure management and achievement of the budgeted tax collection targets."

The Finance Ministry Mandarins do not usually see eye-to-eye with the central bank brass. Yet in a monograph on Central government finances, released on December 14, the Reserve Bank of India (RBI) reminded the Government that its recourse to expenditure management to meet the Budget targets on deficits the previous two years had had but perfunctory outcomes.

Cost of meeting targets

"Efforts to maintain the quantitative targets, however, should not be at the cost of quality of fiscal correction which could deteriorate if recourse is taken to cut back in non-Defence capital outlays and reduction in social sector expenditure." The RBI said the Central government finances during the first half of 2006-07 reflected "some signs of pressure with all the key deficit indicators as a per cent of Budget estimates substantially higher than their levels in the corresponding period of the previous year."

In particular, the revenue deficit widened substantially on account of a steep rise in non-Plan revenue expenditure on interest payments, subsidies and grants to States, nullifying the impressive growth in tax collections. Cutbacks in non-Defence capital outlays, however, moderated the impact on gross fiscal deficit.

In the light of the increase in revenue expenditure, the Government missed the half-year FRBM targets on fiscal and revenue deficits. Against the half-yearly FRBM target of not more than 45 per cent of Budget Estimates, the fiscal deficit during April to September was 58.2 per cent against 55.5 per cent in the corresponding period in 2005. The revenue deficit zoomed from 68.3 per cent in the first half of 2005-06 fiscal to 81.8 per cent for the corresponding period of this fiscal.

While giving credit to the progress in the tax scene during the period under review mainly on account of better direct income and corporation tax and Customs duty collections, the RBI said the excise side needed improvement. The tepid growth in excise collection in the face of booming manufacturing growth demands explanation, not excuses.

Critical challenge

The RBI has asked the Government to ensure the revenue buoyancy of the first half, as that would be "critical to attaining the overall fiscal outcome within the budgeted targets, without compromising on the quality of expenditure management."

The Finance Ministry, in its review of the economy, concedes that, "maintaining macroeconomic stability to enhance investment and sustain the growth momentum on an enduring basis is the critical challenge of the current conjuncture." It also admits that the welfare of farmers, agricultural labour, weavers, workers and weaker sections of society can be enhanced and each family assured a safe and viable livelihood, only through rapid generation of employment. "Sustained and viable employment can be rapidly generated only by boosting agriculture, accelerating improvements in infrastructure and maintaining the growth momentum in industry and services. This broad-based progress is contingent on stepping up investment substantially."

Emphasising higher investments, it cites an earlier estimate that solving the problem of power shortage — essential for faster growth of income and employment — by itself would require an investment of Rs 9,00,000 crore between 2005-06 and 2011-12. Similarly, reversing the agricultural neglect and developing the rural areas would demand substantial investments.

The Review, however, cautions that the anxiety to enhance public investment should not lead to renewed fiscal profligacy. Even as it claims that the three-years-in-a-row growth experience with macro-economic stability has demonstrated the benefits of fiscal prudence, the fact remains that the progress made on the deficit front in this period was achieved through cuts in capital expenditure on vital Plan investment for asset creation.

The trend of poor quality expenditure management even in the first half of the current fiscal has been noted by the central bank which pointed out that the capital outlay during April-September at Rs 17,971 crore declined by 5.5 per cent over the previous year with non-Defence capital outlay being even lower by 18 per cent than its April-September 2005 level. That is why, the RBI said, the focus ought to be on the investment-oriented capital outlays that stimulate economic growth.

The Finance Ministry, however, contends that the "the proclivity of adding new schemes while continuing with the old ones received on a "hand-me-down" basis must be resisted." As the Central finances are getting stretched on a series of populist schemes, as part of the National Common Minimum Programme (NCMP), the Review cautions "against having too ambitious programmes of grants and subventions in areas that are essentially within the domain of the States." It asks the States not only to implement the programmes that belong to their domain — such as primary education, heath care, drinking water, sanitation and roads — but also participate financially and assume ownership of these programmes.

The Centre feels that this is particularly important now, when the recent past has seen considerable improvement in State finances through implementation of the Twelfth Finance Commission award, including debt restructuring and debt waiver and their own robust efforts through a vigorous implementation of VAT (value-added tax).

In cooperative federalism with the power to tax mostly on its side, the Centre has to cut corners to provide for the basic needs of a vast population, particularly in a society that had let market forces free rein. As a result, the benefits of reforms could bypass large sections. It is no wonder that the Approach Paper to the Eleventh Plan (2007-12), which sets store by an inclusive growth strategy, cryptically pointed out that "the only way of meeting the revenue deficit targets of the FRBM as they stand at present is to adjust the time-phasing of those programmes which are revenue-expenditure intensive. However, as this would include precisely the programmes focusing on social inclusiveness, it may not be easy to do unless non-Plan revenue expenditure (mainly subsides) is drastically cut."

One will have to wait till the presentation of the Eleventh Plan first year Union Budget (2007-08) to see how Mr P. Chidambaram treads the fiscal prudence path without compromising on the UPA Government's inclusive growth strategy that forms the bedrock of the next Plan.