S S Tarapore

Financial chaos on the cards

Updated on: Mar 22, 2012
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While the Finance Minister has heroically tried to address the fiscal crisis, the RBI Governor would be well-advised not to take his foot off the brakes until there are clear signs of sustained fiscal consolidation.

Over the years, there have been refinements in the presentation of the Union Budget. With focus on greater transparency and internal consistency in the Budget, there would, hopefully, be less of clever financial engineering and a gradual move to effective adjustment rather than dressed up numbers.

In the initial excitement, commentators have been either very critical or very laudatory regarding individual measures. The focus now has to be on the macroeconomic objectives and the adequacy of the measures to attain these objectives.

In a global setting, wherein governments have lost their nerve and are resorting to unbridled use of the printing press, the persuasive argument is that India cannot be out of step with the trends in the industrial countries, especially as India is now sitting at the High Table of international financial co-ordination of policies.

Word of caution

An elementary word of caution is, however, necessary. In the case of major industrial countries, as well as some of the emerging market economies (EMEs), it could be argued that investment intentions are running lower than savings, which leads to the enticing proposition that the way out of the hole is to pump prime.

Many Indian economists and policymakers would be in broad sympathy with this viewpoint and the authorities are urged to undertake a big-bang reform with giveaways, particularly for the corporate sector, by way of fiscal incentives, low rates of interest and flooding the market with liquidity.

But what if, in India, things are the other way round, i.e. savings are less than investment intentions and growth in 2011-12 of 6.9 per cent is slower than in the heydays of a 9 per cent growth — but, nonetheless, one of the highest in the world.

The spoilsport in the game of wearing rose-tinted glasses is that we have two years of close to double-digit inflation. Opening up of the monetary-fiscal spigots could bring back high inflation, which would then be deeply entrenched in the system.

Fiscal gymnastics

It is in this context that the proposed amendments to the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 are significant. Given the hole we are in, the government had no option but to come up with proposals for a throw-forward of the FRBM Rolling Targets. While macroeconomic numbers show the need for strong fiscal consolidation, the ground realities of coalition politics just do not provide a milieu in which hard decisions can be taken.

The Medium-Term Fiscal Policy Statement, tabled along with the Budget on March 16, is a brilliantly written document which almost convinces the neutral observer to buy the government's new medium-term game plan.

Given the ground realities of the performance in 2011-12, of a revenue deficit of 4.4 per cent of GDP and a gross fiscal deficit (GFD) of 5.9 per cent of GDP, the government's proposed revision to throw forward the earlier targets by another three years appears unavoidable.

According to the proposed new medium targets for 2014-15, the GFD would be 3.9 per cent of GDP and the revenue deficit (RD) 2 per cent of GDP.

In a brilliant act of skilful fiscal gymnastics, it is postulated that the new fiscal indicator from 2011-12, namely “effective revenue deficit”, was to reflect the “structural component of imbalance in the revenue account”.

The “effective revenue deficit” is the difference between the standard revenue deficit and grants for creating capital assets. The Thirteenth Finance Commission's suggestion for a zero revenue deficit by 2013-14 has been substituted by an “effective revenue deficit”, which will now reach zero by 2014-15.

Domestic turmoil

Political economy developments portend that 2014-15 could be a year of domestic turmoil and, without being cynical, one could expect brilliant analysis to say why the “effective revenue deficit” target could not be attained in 2014-15.

One recognises that the government is faced with unavoidable expenditures. I do not tire of repeating the sagacious advice of the eminent New Zealand fiscal economist, C.A.Yandle, who argues that, if one starts from a stable economic environment, new expenditure programmes should be financed from expenditure cuts elsewhere or revenue increases.

But if one starts from an overly expansionary fiscal position, as is the case of India, the stabilisation would require taking into account more revenue/expenditure adjustments than the mere financing of new programmes.

Again, stabilisation usually entails a series of short-term adjustments whereas new major programmes are long-term and invariably growing and cannot be easily trimmed.

This leads to the rather gloomy conclusion that if new programmes are to be enduring, it is necessary, from the outset, to think through these issues, and make policy room for the longer-term fiscal consequences.

All this leads to the conclusion that, notwithstanding the brave efforts by the FM, the Indian economy is in for a period of increasing financial turmoil. While the FM has heroically tried to address the fiscal crisis, the Governor of the Reserve Bank of India would be well advised not to take his foot off the brakes until there are clear signs of sustained fiscal consolidation.

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

Published on March 09, 2018

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