Why this obsession with fiscal deficit?

Fiscal consolidation has always been at the forefront of evaluation of the economic space of a country, and the numbers relating to revenue deficit, fiscal deficit and debt are the variables that are under constant scrutiny. The assumption is that these numbers should be coming down progressively.

The existing framework in India served well considering that fiscal responsibility and budget management (FRBM) was a new concept; it was felt that there was need for signposts that would guide the Government. Evidently, a review is required as the FRBM Act, now 13 years old, needs to be revisited.

The purpose of setting these goal-posts was to ensure there was some discipline in government borrowing as it was believed that without such norms, there would be no end to fiscal spending. These rules were applied at both the central and State levels. While it was a case of self-discipline at the Centre, States did not have a choice, with the Centre playing the role of monitor as permitted by the Constitution.

It has worked fairly well; while most States have been compliant, the Centre too has observed the new norm, even as it has taken the liberty to deviate when necessary. There is always the clause of “exceptional circumstances” which provide an alternative route.

There is an ideological question today over the relevance of FRBM.  The role of the government in any country is to bring about economic development and step into areas where the private sector would not, as well as address social needs. Therefore, governments need to spend money for which they have to borrow from the market.

Ironically, if governments decided not to borrow there would be a problem in the monetary space as there would be no securities to hold or trade, and this would impact the financial system. The SLR (statutory liquidity ratio) actually helps the system and rewards banks — the fact that banks voluntarily hold on to such paper bears testimony to the value attached to G-secs despite the constant demand that the SLR be lowered. Further, the SLR actually provides a strong liquidity buffer for banks, especially the weak ones.

Besides, if the government is able to borrow funds in domestic currency thus not posing any risk to the global system and is able to manage liquidity in a manner where the private sector is not crowded out under stable inflationary conditions, then one cannot have any quarrel with such borrowings.

Therefore, setting such targets for the Centre in terms of how much can be borrowed could be debated, though at the State level, it can still be defended. Two issues stand out. The first is that by framing such norms on government borrowing, it has been seen anecdotally that sticking to the norm becomes a goal for the government and supersedes other obligations. The result is that we always seem to be working backwards after anchoring this number. Consequently, expenditure has to be pulled back and the onus falls on discretionary expenditure, which often is capital expenditure. This malaise has come in the way of growth picking up through a Keynesian stimulus. The views of global rating agencies and other multilateral bodies appear to become more important and the FRBM route is persevered with. Hence, while a number of developed countries are pump-priming their economies, we are unable to do so because of this self-imposed constraint. Such action or inaction can affect the economy, as was the case during FY13-FY15, when fiscal targets were met at the cost of investment even as the private sector was not spending.

The second conundrum relates more to State finances. While they have been allowed space of 3 per cent fiscal deficit with some being allowed to go to 3.5 per cent due to their special status, the current UDAY (Ujwal DISCOM Assurance Yojana) scheme provides an exemption for DISCOM debt. While this is a good step, it erodes the sanctity of the FRBM rules. While these kinds of problems will come up regularly, the FRBM rules have to be relaxed.

How then should we view FRBM? It should not be carved in stone and must provide a broad range within which the Government should function. There is nothing sacrosanct about numbers such as 3 per cent for the Centre and 3 per cent for all States combined. It could be 2 or 4 per cent.

Allowing a wider range will always be prudent so that the government could work according to three factors: state of the economy, liquidity status and contingency actions (such as UDAY). The advantage that India has is that all debt is internal and does not involve external financial borrowing or assistance.

Also, there is little evidence to show that higher government spending leads to demand-pull inflation as we have been perennially afflicted by supply-side pressures. Further, with excess borrowing being earmarked to spending on infrastructure projects, the likelihood of generating demand pull forces would be mitigated.

The basic takeaway is that FRBM should be a guiding light, but not the be-all-and-end-all when drawing up a budget.

It has become almost axiomatic that the Government should be spending on infrastructure in a big way since the private sector does not have the same bandwidth. This will never be possible as there are several committed expenditures such as interest payments, subsidies, salaries and pensions, besides other welfare schemes. Going beyond these fiduciary duties will require more space at times, especially when economic growth slows down.

Hence, it is hoped that the new FRBM rules will impart this flexibility, leaving it open to the respective governments to decide how best to interpret the limits. There could be floods, droughts, public sector requirements (for PSBs), salary revisions and so on, requiring financial commitments. This would require the government to look beyond rigid fiscal deficit to GDP ratios.

The Government will become a more pro-active agent of development as we move away from blind adherence of self-imposed norms. Ideally, a corridor should be specified within which the government deficit could move.

The writer is chief economist at CARE Ratings. The views are personal

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