Budget and myths of fiscal consolidation

Democracy has a deficit bias and India is no exception to this. In order to break this, India embarked upon a self-imposed fiscal rule in terms of Fiscal Responsibility and Budget Management (FRBM) Act 2003 and FRBM rule 2004.

The FRBM rule prescribed the annual targets for reduction of fiscal deficit and revenue deficit so as to eliminate revenue deficit by end-March 2008 and reduce fiscal deficit to 3 per cent of the GDP by the same time. The FRBM enabled fiscal discipline through fiscal correction and consolidation measures.

Accordingly, by 2007-08 the fiscal deficit was reduced to 2.5 per cent of GDP. However, the revenue deficit could not be eliminated and remained at 1.1 per cent of GDP

In line with the many other countries, India also extended fiscal stimulus measures both in terms of tax reductions and expenditure enhancement in the wake of the global economic crisis. As a result, the fiscal and revenue deficit were recorded at higher levels of 6.4 per cent and 5.2 per cent of GDP during 2009-10, respectively. While presenting the budget for 2010-11, an attempt was made to exit from the fiscal stimulus programme.

The announcements of revised roadmap, introduction of a new concept of effective revenue deficit, revisiting the Plan, non-Plan revenue and capital expenditures, and treatment of subsidies raise doubts on the reliability of the fiscal consolidation exercise. Since the government is bound by the Act to carry out necessary corrections and consolidation, some of the myths are worth examining.

Redefining the revenue deficit concept: The concept of effective revenue deficit (excluding the grants for creation of capital assets) has been introduced in the budget, thereby bringing down the revenue deficit from 3.4 per cent to 1.8 per cent of GDP. It is noteworthy to observe that the annual financial statement (AFS), which is a constitutional requirement, provides heads of accounts of revenue and capital budgets specifying grants-in-aid as a revenue expenditure. Operationally the end-use of the grants-in-aid funds is managed by the State governments. Even admitting that these are used by the States for creation of capital assets, it is not convincing how these expenditures could be treated as non-revenue expenditure by the Central government. This needs to be clarified.

Revised roadmap : The budget has announced that in the course of the year the government would introduce an amendment to the FRBM Act laying down the fiscal roadmap for the next five years. The Thirteenth Finance Commission has already put in place a revised fiscal architecture. It is appropriate that the Central government recognises the technical efforts undertaken by the Commission and follow the roadmap as suggested by it. One gets a doubt whether such a revised roadmap by the government is a step to accommodate the effective revenue deficit as a target. Thus, fiscal consolidation in terms of a revised roadmap raises more questions.

Process of fiscal consolidation in 2010-11 (Revised Estimate) and 2011-12 (Budget Estimate): It is pertinent to note that the fiscal deficit budgeted at Rs 3,81,408 crore for the financial year 2010-11, translated into Rs 4,00,998 crore in the revised estimates. Thus, there is a slippage to the tune of around Rs 20,000 crore or 4.2 per cent. Since the GDP for the year in the advanced estimates increased by Rs 9, 43,247 crore, the cushion was available to lower the fiscal deficit in terms of GDP by 0.4 percentage points to 5.1 per cent.

The reduction in revenue deficit by Rs 6,668 crore was mainly on account of substantial increase in non-tax revenue, particularly in other communication services (3G and BWA Spectrum Auction) by Rs 71,007 crore apart from the increase in net tax revenue to the Centre by Rs 28,591 crore (or nearly Rs 1 lakh crore combined). Higher realisation in revenue was spent on non-Plan revenue expenditure to the tune of Rs 83,150 crore of which petroleum subsidy was nearly Rs 35,000 crore.

Thus, fiscal consolidation in the revised estimate was essentially geared to accommodating the deficit of the oil marketing companies.

The above analysis suggests that there is no expenditure management as such. Higher revenue realisations gave the comfort for the government to accommodate under-recoveries of the oil marketing companies.

Similarly, the fiscal consolidation in 2011-12 is based on the assumption of higher tax collections, assuming a growth rate of 18.5 percent on the top of an increase of 26 per cent in the revised estimate for 2010-11. Expenditure management in the budget 2011-12 remains a myth with regard to petroleum subsidies as the amount has been placed at Rs 23,640 crore against the large scale under-recoveries of oil marketing companies and the rise in international oil prices.

The fiscal consolidation process has been back-loaded as the revenue deficit is projected at 2.1 per cent as against zero by the Thirteenth Finance Commission during 2013-14. Thus, elimination of revenue deficit in the fiscal consolidation process largely remains a myth.

Revisiting expenditure classification: One wonders as to why in the midst of fiscal consolidation process there is an attempt to revisit expenditure classification. The shifting of some heads of revenue expenditure to capital and some heads of capital to revenue is being done in the economic and functional classification of the budget. There is no need and urgency to reinvent the wheel. In the spirit of budget integrity, transparency and credibility, the fiscal consolidation process should meet its target of elimination of revenue deficit with the present classification itself. As suggested by the Thirteenth Finance Commission, the revenue deficit should be eliminated by 2013-14. There is no need to revisit expenditure classification or redefine deficit indicators to one's convenience.