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Fiscal prudence

Deficits, responsibilities and actions

Economic reforms have made the people of India realise that a goverment's
performance has to be judged by the rate of growth of the economy under its
policies. Consequently, there has been a palpable paradigm change in the
election manifestoes of different political parties. Will these be
reflected in their actions?

Political parties have been vying with one another to set out goals in
their manifestoes to achieve a designated rate of economic growth. They
have recognised the importance of good fiscal governance for sustained
economic growth and financial stability. There is also a growing awareness
that profligacy in government expenditure leads only to increasing fiscal
deficits - a matter that has to be viewed with concern and attended to
urgently. The recently announced election manifestoes, particularly those
of the BJP and the Congress, attempt to push reforms. Ambitious goals have
been set by both parties, little realising that many of their objectives
are conflicting and are not easily realisable. Economic compulsions

In 1991, the balance of payment crisis compelled India to adopt reforms in
areas hitherto the hunting ground for every possible section of Indian
society, to gain advantage, without any consideration for the larger public
welfare and economic growth. India had tied itself into multiple knots of
import and export controls, licensing and regimentation of industry,
forbidding foreign investment, regulating import of technology and also
preventing healthy competition. The result was a country which just
lumbered along with its teeming millions dragging themselves in a state of
poverty, while countries which were far behind India, like Malaysia,
Thailand and Indonesia, forged ahead by eliminating poverty and moving on
the path of prosperity.

India got pushed into a corner, by its own follies and was forced to look
around the world for a way out of the payment crisis. In 1991, the
International Monetary Fund (IMF) was approached once again for a stand-by
assistance. It laid down its rigorous conditionalities and the government
of India agreed to free the country from a controlled regime

The launching of reforms on all fronts, by the government of P V Narasimha
Rao, set the pace for future governments to follow.

Despite the realisation that stability in the economy could be achieved
only by a government controlling its fiscal deficit, which had been around
8-10 per cent since the Seventies, there has been no sustained and
consistent effort to balance government revenues and expenditures. The only
heroic attempt at deficit reduction was done in the years 1991-92 and
1992-93, when the deficit at the Centre was brought down substantially. Tax
reforms carried out in 1994-95 gave a boost to revenues. However, since
1994-95, there has been no consistency in deficit reduction which still
hovers around 10 per cent - perhaps, the highest fiscal deficit to be
registered by any country in the world, whose data figures in government
finance statistics or at the IMF. The combined revenue deficits of the
states have more than doubled in 1998-99 compared to 1997-98 (Annual
Report, RBI, pp 90).

A good Brazilian example

The recent financial crisis in Brazil has been ascribed to its
unsustainable fiscal deficit run up by both by the federal government and
its constituent states. As a price for obtaining a large assistance package
from the IMF and from friendly governments, Brazil had to adopt
extraordinary measures to contain fiscal deficit, not only at the federal
level but also at the state level. The fact that the Brazilian economy has
stabilised in a matter of 3 - 4 months after the crisis, is a tribute to
the determination of the Brazilian government to bring back order in its
finances. While there are a number of diffe-rences between the Brazilian
and Indian federal systems, the recent experience of Brazil holds important
lessons for India.

The unique situation in India leads to the inexorable conclusion that the
government - having no will to widen the tax base, improve its revenues,
reduce its public sector losses or control its unessential and wasteful
expenditure - has been left with no option but to resort to the inflation
tax and borrowings. This has pre-empted the private sector of using
household savings, which they could have more fruitfully employed at lower
rates of interest. The worst sufferers on account of this policy has been
the Indian economy in general and the fixed income earners in particular.
The inevitable distortions in allocation of resources and the creation of a
vast underground economy have been the final products of the mess.

Deficit inertia

Since 1991, no budget speech has been delivered by any Finance Minister
without a reference to the need for reducing fiscal deficit. The common
Minimum Programme of the United Front government made a solemn promise to
reduce the fiscal deficit to 4 per cent. The BJP led alliance did also show
its earnestness in trying to garner more resources, even by raising custom
duties, which may not have been the correct way of doing so. Nevertheless,
the fiscal deficit has reluctantly remained at its original level, leaving
India in some kind of a "deficit inertia," with a lack of motive power in
any of the governments to make it move out of the path of India's progress.

The BJP led alliance has said that they plan to revitalise economic reforms
and has expressed its willingness to examine the possibility of enacting a
Fiscal Responsibility Act (MM) to discipline government finances.

The Congress manifesto was even more ambitious but has become irrelevant in
the context of its defeat at the polls. Even P Chidambaram, finance
minister in UF government (1996-98), referred to the constitution of an
Expenditure Management and Reform Commission in his Budget speech for the
year 1996-97 but did not set up one; Yashwant Sinha repeated this in his
budget speech for the year 1999-2000.

The founding fathers of our Constitution had been wise enough to envision a
situation when the government would resort to borrowings, rather than
taxation, to finance its expenditure and made an enabling provision to
restrict government borrowings and guarantees. A similar provision had been
incorporated for the states, under Article 293, to enable them to pass
their own laws to limit borrowings and guarantees. But in the last 50
years, no government considered seriously these provisions of the
Constitution. (It is reported that Karnataka state have passed a law
limiting borrowing and issue of guarantees by the state government).

Play of politics

The problem with our country is, since the Eighties when the finances of
the states and the Central government started deteriorating, political
control over administration has also been slipping. It has regressively
fallen into the hands of inexperienced politicians in many states who have
come to power more by their sinews than by their capacity. First there has
to be a will to govern - but there is only a desire. It has to be
altruistically moti- vated to provide good governance, to right the wrongs
and increase public welfare. The desire to govern is, however, manifested
in most cases, to exercise power and make a quick buck exemplified by the
proliferating number of public scandals. There has been no financial
collapse in the country as in Brazil or Russia, because, the country in a
closed economy that has trade to GDP ratio at around 15 per cent - the
sufferers are the Indian masses, with around 30 per cent living below the
poverty line. The lack of will to go-vern is seen in the chaotic state of
traffic, the filth and rubbish even in metropolitan cities - the worst
being Chennai- the number of pavement dwellers in Mumbai and the inability
to run a financial administration.

The manifestoes do not adumbrate action points and time schedules for
achievement of objectives in all these areas. The Congress and the BJP have
erudite scholars amongst them who know what ails this country and what
requires to be done. Neither require a consultant; but the problem is, who
will enforce the laws with an iron hand regardless of affinities?

(Excerpts from a discussion paper prepared by the author with the
assistance of Dr.Sudipa Majumdar, Research Scholar, IGIDR, Mumbai.)

Author:
M R Sivaraman was formerly executive director of International Monetary
Fund and revenue secretary, India.

Courtesy: http://business.webindia.com
Article courtesy: Industrial Economist