Fiscal consolidation – a missed opportunity

Without detracting from the importance of other variables, one can say that a major impact on the economy from Budget 2012-13 can be summed up in terms of the fiscal deficit.

The Finance Minister has indicated that it would be 5.1 per cent of GDP. Though it marks a decline from the previous year, it is still on the high side, which would make it difficult for the RBI to adopt a liberalising policy in the near future.

The Government has missed an opportunity to engage in a massive resource-raising exercise.

The amount of Rs 41,440 crore estimated as net gain to government from the Budget proposals is impressive.

One should, however, note that it is small in relation to the potential available.

There is no possibility of any expenditure cut, especially in relation to subsidies, in what may turn out to be an election year.

The Government can only hope to moderate its growth. The Government could have easily tapped the sources of wealth tax and dividend tax to raise a substantial amount to bring down the deficit (See Budget should not spare super-rich , February 24, 2012).

It would not have affected the electoral chances of the parties in power. Only the rich, a small proportion of the electorate, who, in any case, do not go to the polling booth, would have been impacted.

The only remaining hope now is the likelihood of a large revenue arising from the auction of 2G spectrum.

Debt management

In its report on the working of the British monetary system (1959), the Radcliffe Committee made a perceptive statement: “The debt is not, that is to say, to be regarded as a residual among quantities of economic policy…. Thus debt management can be regarded neither as something to be, as it were, left to the last and adjusted to all other policy decisions , nor on the other hand, as a consideration which should override all other policy decisions; it has to be integrated with a variety of measures in the pursuit of the broad aims of economic policy.”

On this score there is little evidence of an integrated and harmonious approach to the three major segments of policy making, viz., fiscal, monetary and debt management policies.

The FM has indicated that the debt-to-GDP ratio will come down to 45.5 per cent in 2012-13. Obviously it excludes external debt.

As of September 2011, India's total public debt stood at 62.43 per cent of GDP, which is highest among the emerging economies.

The Government claims that the nation's reserves are about equal to external debt. It is no consolation. For the economy to be considered solvent, the forex reserves should be adequate to cover the total debt, as they are real resources unlike the IOUs of government.

As it is, the servicing of the debt will cast a tremendous burden on the economy. Add to it what we would see as additions in the Twelfth Plan period where nearly a trillion dollar worth of investment in infrastructure will be made, obviously financed mostly by borrowings.

ECBs and liquidity

The Budget provides for External Commercial Borrowings (ECB) for some more sectors. What is the advantage of ECB? The borrower gets funds at a low rate. How low it is depends on the local rates, the cost of hedging and related expenses. When the rupee depreciated recently this advantage ceased.

Does it improve liquidity? No. The ECB borrower will deposit the money in his bank, which will issue rupees in lieu thereof.

It means that there is no accretion to liquidity. Only if the RBI buys the currency there can be any addition to money supply.

To the extent ECB borrowings take away a part of banks' rupee resources, there will be less available for other normal loans.

Would it not be better if the RBI opened a refinance window for forex loans on terms that are competitive internationally? The advantage is there is no increase in external debt.

Further, the RBI can earn a better return on its reserves than what it is getting now.

It is a much better deployment of forex resources than the futile exercises of market intervention.

Amendments to FRBMA Act

The Government has proposed amendments to the Fiscal Responsibility and Budget Management Act (FRBMA). Details are not known.

One badly needed amendment is the provision for placing the market loans with the RBI initially, which can unload them on the market as and when the conditions are favourable — a practice followed with success before the advent of the FRBMA.

Under the current system of buybacks, the fiscal deficit gets monetised and there is no chance of its reduction until the bonds mature.

In case the procedure suggested above is followed, although there is monetisation of deficit to begin with, it gets progressively reduced within a short period through open market operations.

The author is a Mumbai-based economic consultant.

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