MACROSCAN. What fiscal failure is all about

The Finance Ministry’s mid-year review candidly confesses that the revenue projections in Budget 2014-15 were overly over- optimistic, making the task of realising the fiscal deficit target of 4.1 per cent of GDP challenging. This confession seems to pave the ground for a combination of large-scale expenditure cuts that would be revealed when the next budget is presented and a possible failure to realise the ‘ambitious’ fiscal deficit target.

Thus, the mid-year review makes the startling assessment that revenue projections in the Budget were inflated to the tune of 0.84 per cent of GDP or ₹1,05,000 crore. Further, the current budget is burdened by a ‘legacy effect’ in the form of carryover of expenditures from the past, which is placed at anywhere between 0.3 and 1 per cent of GDP. With the combination of shortfalls in revenues and clearance of past dues eating up budgeted resources to the tune of anywhere up to 1.84 per cent of GDP, meeting the stringent fiscal deficit target is bound to be extremely difficult.

But since the government seems to be hell-bent on pursuing that goal, two developments are inevitable in the coming months. One is an accelerated privatisation drive (including sale of resources such as spectrum and coal blocks), and the other is an indiscriminate slashing of welfare and developmental expenditure. The mid-year review signals where such cuts are likely to come when it unabashedly refers positively to ‘reductions in MGNREGA expenditures’, and holds that ‘declines of 3 and 36 per cent in the last two years’ have helped moderate rural wage growth and, via that, inflationary pressures.

Figures released by the Controller General of Accounts (CGA) point to the direction of short-term fiscal trends. According to those figures, expenditures during the first seven months of the fiscal year (April to October) were equal to 53.6 per of the expenditure budgeted for the year as a whole. If expenditure had been evenly spread out over the year, the figure for April to October should have been 58.5 per cent, so the shortfall appears not too severe as yet.

However, the budgeted level of expenditure itself was grossly inadequate, and was the result of Finance Minister Arun Jaitley’s decision to stick to his predecessor’s fiscal deficit target of 4.1 per cent of GDP. The mid-year review merely underlines the fact that despite limiting expenditures, the government is hard put to meet the fiscal deficit target because revenue generation has fallen short of budgetary projections. The CGA figures show that, because revenue receipts during April to October 2014 have amounted only to 38.5 per cent of that projected for the full year in Budget 2014-15, the fiscal deficit (or the excess of expenditures over revenue receipts and non-debt capital receipts) over these months is in absolute terms as much as 89.6 per cent of that budgeted.

Thus, if the Finance Minister is serious about sticking to his deficit target, only a spike in receipts or a further sharp reduction in expenditures can get him anywhere near there. Not surprisingly he has already announced a 10 per cent cut in allocations relative to budgetary provisions for different ministries, while absorbing the benefit of an oil price fall (which under the current liberalised regime should have benefited the consumer) in the form of higher taxes on petroleum products. Further, according to leaked news that is not officially confirmed, the government plans on a huge reduction in expenditures on subsidies and the MGNREGS in a desperate bid to meet the deficit target.

In addition, the government is expected to rely on receipts from disinvestment and the sale of resources such as spectrum. The Budget, for example, had provided for ₹63,425 crore in the form of ‘miscellaneous capital receipts’, which was to come from disinvestment of government equity in profit-making PSUs (₹43,425 crore), sale of scarce public resources and retrenchment of government equity holdings in non-government companies (together ₹20,000 crore). As of October, receipts under this head are placed at a negligible ₹217 crore.

So, besides cost cuts, what we can expect is an equally desperate privatisation-and-asset-sale drive over the coming months. Since the receipts from such sales are treated as ‘non-debt capital receipts’, they would help rein in the fiscal deficit while keeping expenditure on track to meet the budgetary projection.

What these short-term trends mirror is the fix that both UPA and NDA governments have got themselves into because of the adoption of a contradictory long-term fiscal policy in the name of neoliberal ‘reform’. An undeclared feature of that policy is tax lenience and forbearance, sometimes pursued in the name of rationalising the tax system and at other times adopted as part of the scheme of incentivising private investment. The net result is that though it is well recognised that India is a low tax nation when assessed in terms of its tax GDP ratio, fiscal ‘reform’ has done little to raise that ratio.

There are three features revealed by trends in the central tax-to-GDP ratio since 1990 (Chart 1). The first is that the immediate effect of reform was not to improve but to depress the tax-GDP ratio that fell from 10 per cent in 1991-92 to 7.97 per cent in 1998-99. The second is the claim that fiscal reform had addressed the problem of a low tax-GDP ratio based on figures relating to 2006-08 cannot be sustained. In fact, the improvement in tax performance during 2003-04 and 2007-08 was the result of the level and nature of growth during the mid-2000s, when high growth was accompanied by sharp increases in corporate profits and an unusual expansion of services. When growth was affected by the global crisis and the government had to provide some tax concession as part of the stimulus package it adopted, the ratio fell during 2008-10. Third, on average after 2007-08, the tax to GDP ratio has found a lower level despite variations in annual growth.

In sum, the effect of fiscal reform on the revenue side seems to be the failure to correct the long-term inadequacy of the tax effort at the central level, and an aggravation of the pro-cyclicality of revenue mobilisation. Higher growth seems to yield higher revenues, while a slowdown depresses revenues — as the mid-year review laments.

When this failure is combined with the neoliberal commitment to what is euphemistically called fiscal consolidation in the form of a reduced fiscal deficit to GDP ratio, the impact on expenditure can only be adverse. As Chart 2 shows, the ratio of total central government expenditure to GDP fell sharply in the first decade-and-a-half after the ‘reform’ began. It remained at indifferent levels even during the high growth years till 2007-08, and then rose as part of the consciously adopted stimulus package in the aftermath of the global crisis. These trends point to the fact that the 2000s boom in the Indian economy was not driven by public expenditure, but by private consumption and investment expenditures that were in substantial measure debt-financed, and facilitated by a credit boom in the economy. That boom has now ended.

The trap the government finds itself in is that, despite holding back on expenditure, its success in reining in the fiscal deficit has only been partial. The Fiscal Responsibility and Budget Management Act was adopted in 2003 and amended in 2012. But targets have been deferred time and again, and the government is not on track to meet its goal of a deficit of 3 per cent of GDP by financial year 2017 (Chart 3). The only time it appeared that the government was on track were the high growth years between 2003-04 and 2007-08. Even then, the remarkably low 2.5 per cent figure for 2007-08 was largely because of windfall receipts of ₹12,500 crore from sale of telecom spectrum to new entrants.

Thus, fiscal reform in India has failed because it has done little to increase revenue generation through taxation. The result is that ‘fiscal consolidation’ has essentially been through reining in expenditure. But even that has proved inadequate, excepting when asset sales have allowed to government to window dress its accounts.

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