MAVERICK VIEW. Fiscal correction not to be trifled with

In a world of instant analysis, most commentators are through with their assessment of Finance Minister Arun Jaitley’s Budget. This column focuses attention on some select enduring aspects of the fisc.

The Budget sets out a perspective of attaining 7-8 per cent growth within the next three-four years with effective control of inflation. The global situation is still worrisome and with endemic problems in the Indian economy it is prudent not to generate anticipations of unattainable objectives.

Given that more than three months of the current financial year are over, it is only appropriate to project a 5.5-6.0 per cent growth rate in 2014-15. Raising savings and easing infrastructural constraints will take time and the Finance Minister deserves kudos for opting for a modest Budget.

It sets out a medium-term objective of attaining a fiscal deficit of 3.0 per cent of GDP by 2016-17. More important than the numbers is the quality of the fiscal adjustment, that is, eschewing fiscal gimmicks to show a lower deficit.

At the outset, the Finance Minister emphasised fiscal prudence on considerations of inter-generational equity. This contrasts with an erroneous viewpoint articulated by most fiscal economists that there is no inter-generational burden of excessive government borrowing. By persistently spending beyond its means, government debt has spiralled and future generations are left with the problem of repayment. When the debt is repaid some segments of society have to bear the burden of repayment.

The erroneous view that has prevailed is that there is no limit to piling up internal debt. This is reflected in the approach that all that matters is net borrowing; repayment will be automatically refinanced by existing holders of government paper. This would hold when the repayment is small and fresh borrowing is assured through prescription of high pre-emptions. With the reduction of pre-emptions, there is no assurance that repayments will be automatically financed by fresh investments in government paper. As such there is a strong possibility an internal debt explosion.

Finance Commissions in the 1980s and early 1990s emphasised that there should be a viable programme of debt repayment through measures such as a consolidated sinking fund (CSF). Such a fund needs to be built up by allocating a small percentage, say 3 per cent, of the amount of fresh borrowing. Again, disinvestment, that is, sale of the family silver, should be entirely used to build up a CSF; furthermore, transfer of profits to the Government from the Reserve Bank of India (RBI) results in created money and such profit transfers should be allocated to the CSF.

In 1996, the RBI, at the behest of the Ministry of Finance and successive Finance Commissions, prepared a comprehensive plan for building up a CSF which would, over time, ensure repayments. The fiscal pundits dismissed this proposal on the ground that a CSF was not meaningful so long as there was a fiscal deficit.

Before catastrophe strikes, the Government would do well to specifically request the Fourteenth Finance Commission to evolve a watertight scheme to ensure repayment of government borrowing.

A seminal idea is the setting up of an Expenditure Management Commission (EMC) which will give an interim report in the current financial year and a final report later. It would be preferable if the Commission were to give a series of reports on specific expenditures using the 80/20 rule by concentrating on select areas (say, 20 per cent of all areas) which have a potential for substantial savings (say, 80 per cent of all savings). Further, the Commission should look into issues of enhancing the productivity of expenditure.

An area of priority is the curtailment of subsidies. These are sensitive issues and sharp and sudden cuts in subsidies result in predictable rollbacks. The Commission should use the “boiling frog” technique (a frog jumps out when placed in boiling water but is caught unawares and cooked when in cold water that heats up gradually) to devise a well calibrated gradual reduction in subsidies. There is also the important issue of “quasi-government” expenditure wherein public sector units are muscled into bearing government expenditure.

The Budget emphasises the need for a modern monetary policy framework; the Government will work in close consultation with the RBI to put it in place. There is reason to believe that the Government will not continue with its predecessor’s confrontationist approach to the formulation and operation of monetary policy.

On the issue of legislative reform of the structure of financial regulation, the Government should have a positive dialogue with existing regulators by adopting an eclectic approach. As opposed to the antipathy shown by both the FSLRC and the erstwhile government to existing regulators, the legislative framework should be strengthened. Reforms are obviously necessary, but this should be undertaken in consultation with existing regulators and after following due parliamentary procedures. The Government should refrain from sabre-rattling.

A basic prerequisite for a well-developed, vibrant, deep and liquid corporate bond market is an efficient government securities market which is not based on pre-emptions, and where investors have different perceptions and different time horizons. The Government should accept the basic dictum that it cannot raise unlimited amounts at low rates of interest. Once sovereign bond investors are freed from pre-emptions and interest rates are genuinely market determined, the corporate bond market would develop with a premium over the sovereign’s borrowing rate. There can be no free lunch for the corporate sector which would enable it to borrow at sub-market rates of interest.

The writer is a Mumbai-based economist