G. Srinvasan

New Delhi, Aug. 15 As India wrestles with a possible successor framework to the Fiscal Responsibility and Budget Management Act (FRBMA), following the ballooning of deficit last year, the country’s experience with fiscal rules has so far been ‘mixed’.

This is the broad conclusion of a working paper just published by two senior IMF economists Alejandro Sergio Simone and Petia Topalova.

Reviewing the performance, they said until 2007-08, the advent of fiscal responsibility law coincided with improvements in key indicators as, between 2003-04 and 2007-08, the Centre’s fiscal deficit declined from 5.1 per cent to 2.8 per cent of GDP, achieving a year in advance the medium-term target of 3 per cent of GDP. The reduction in the Central government’s revenue deficit was equally notable at 1.2 per cent of GDP in 2007-08 and it was a third of the 2003-04 level.

The IMF paper said the improvements in the fiscal position suggested by the headline indicators, however, pale when broader fiscal indicators for the same period are considered. The pressure to comply with the numerical fiscal targets encouraged the increasing use of subsidy-related bonds to meet current spending needs. Compensation to state-owned oil marketing companies, the Food Corporation of India and fertiliser producers for losses incurred from the subsidised provision of commodities was provided through the issue of special bonds. “If these quasi-fiscal expenditures are taken into account, the actual fiscal adjustment until 2007-08 has been less than the headline budget numbers would suggest,” it said.

Fiscal deficit

Stating that India’s fiscal deficit was set to deteriorate well before any calls for crisis-related fiscal stimulus measures, it said the 2008-09 Budget introduced a spate of costly schemes such as debt write-off for farmers, an expansion of the National Rural Employment Guarantee scheme and a revision of the income tax brackets, besides implementation of 20 per cent hike to government employees. In the absence of expenditure reforms, the subsidy bill rose dramatically and these developments undermined the credibility of government’s commitment to fiscal discipline.

With roughly half of the general government fiscal deficit accounted for by States, the IMF economists said their aggregate fiscal consolidation masks a relatively modest adjustment that could be ascribed purely to States’ own fiscal efforts.

The IMF paper lists main weaknesses in India’s current FRBMA as absence of well-defined accounting definitions for target fiscal indicators, insufficient transparency in budget preparation, focus on deficit type targets, and lack of expenditure rules and a debt target.

A case of absence of well-defined accounting definitions relates to the issue of special bonds (subsidy-related bonds) and these “creative accounting measures undermine the credibility of government’s commitment to fiscal discipline”, the paper cautioned.

Other shortcomings in the Act, according to the IMF paper, include absence of well-defined sanctions for non-compliance, widely defined escape clauses and no independent assessment of compliance with the FRBMA. Hence, the Fund officials contend that given the guiding role of the Centre, the reform should begin by re-establishing fiscal discipline at the Centre as soon as macroeconomic conditions improve.

To reduce opportunities for creative accounting and biased forecasts, the IMF paper calls for precision in the definition of the accounting framework and definitions for target fiscal indicators. There should be an empowered independent scorekeeper and suggests considering expanding the role of agencies that monitor government funds such as Comptroller and Auditor General.

Second, the new FRBMA numerical targets should be bolstered by a concrete underlying plan of short- and medium-term policy measures for both revenue and expenditure. Third, in order to focus medium-term fiscal policy on debt sustainability, the government may consider using debt and expenditure growth targets. A direct rule on gross public debt should be a logical part of the FRBMA successor which should also be prudently defined to let some room for discretionary countercyclical fiscal policy if automatic stabilisers were not sufficient.

To strengthen States’ fiscal responsibility, the Centre should define sub-national debt targets that are consistent with national debt-reduction objectives with the repayment capacity of the different States and ensure timely and reliable reporting of their fiscal operations.

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(This article was published in the Business Line print edition dated August 16, 2009)
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