When the Reserve Bank of India did not read any thing substantial in the two-page statement on fiscal consolidation, Finance Minister P. Chidambaram thought it was time for silence.
But the silence after announcement of much hyped five-year road map for fiscal consolidation can speak volumes.
The reason is simple. Everybody wants to know, first, how credible this road map is, second, what is the action plan for this fiscal consolidation and third, does history support Chidambaram’s optimism?
All those who responded talked about the timing. The announcement has come at a time, when the Finance Ministry has started preparation for the general Budget which can be termed as final full-fledged Budget of the Government before the General Election in 2014.
Economists believe that the last full-fledged Budget will have everything but hard economic decisions. However, the Finance Ministry’s mandarins claimed that Chidambaram has factored in not just timing but also political reality.
Question of credibility
Talk of political realism raises the question about the credibility of the blueprint for fiscal consolidation.
Sunil Sinha, Principal Economist with Crisil, says, “What the Finance Minister has stated is just the first step. Until and unless rest of the steps are laid out, credibility will always be in doubt.”
Echoing the same sentiment, D.K. Pant, Director and Head of Public Finance with India Ratings and Research believes, “When revenue collection is sluggish, expenditure control becomes important to check the fiscal deficit. Beside some rejig on the petroleum front, we do not see much action on expenditure side which can provide credibility to fiscal consolidation plan.”
Action plan
Even a section of the Government is sceptical about the plan, but a senior Finance Ministry official claimed that that there was a concrete plan and work on it is in progress.
“Trust us, all these actions will bring about credibility to the fiscal consolidation roadmap,” they said.
Next, the action plan. Generally speaking, any fiscal correction plan has three components: raising tax and non-tax receipts, cutting expenditure (especially non-Plan) and achieving higher growth which in turn will bring buoyancy in tax receipts.
Tax revenue can be raised either by increasing the tax rates or increasing the compliance; expenditure can be cut by reducing subsidy and wasteful expenses while growth requires investment and policy boost.
However, Nomura’s economist Sonal Verma commented, “The roadmap is a step in the right direction, but it lacks detail. In our view, the measures announced will be insufficient to contain the fiscal deficit at 5.3 per cent of GDP in FY13 (Nomura‘s projection: 5.8 per cent) due to higher subsidies and lower tax revenues. Moreover, as with other reform measures announced so far, implementation remains key.”
Countering this, the Finance Ministry official said that the growth driver in tax revenue will be implementation of Direct Taxes Code (DTC) and Goods and Services Tax (GST). These two have the potential to boost the tax revenue without increasing the tax rates.
At the same time recent action by the Prime Minister himself on direct cash transfer will plug the subsidy leakage, he added.
Sinha and Pant, however, do not subscribe these theories.
Sinha said that implementation of GST and DTC will have impact only after some time. At the same time, there is no clarity on when these two will be implemented. Adding to this, Pant cautioned about losses in the initial years from the introduction of tax reforms which will put a burden on the Central exchequer.
‘Doable’ vs ‘challenging’
Finally, past records are also raising doubts. The Government says it is adopting a ‘doable’ target of 5.3 per cent against the ‘challenging’ target of 5.1 per cent of fiscal deficit for 2012-13.
But the general perception is that even 5.3 per cent is ambitious and a more realistic target will be 5.8-5.9 per cent.
Economists say, the Government failed to meet the target of 4.6 per cent and ended with a fiscal deficit of 5.8 per cent of GDP last year. The situation has not improved since, in fact, it has deteriorated.
According to Pant, historical evidence says that when growth rate declines, it does have a similar effect on the revenue but expenditure remains as it was in previous growth scenario. So the mismatch widens.
“Budget projection about revenue growth and expenditure growth was on the assumption of growth rate of around 7.5 per cent, now we are talking about six per cent. So, naturally, this will have an impact on growth of revenue and consequently on fiscal deficit,” Pant added.
So, should this plan be rejected or accepted with caution?
Sinha says if the new plan is incorporated as an amendment to the Fiscal Responsibility and Budget Management (FRBM) Act, it will add credibility as it will become a statutory responsibility for the Government.
Coincidently, the Finance Minister has assured for an amendment in the Act.