Problems with ‘effective revenue deficit’

The Fiscal Responsibility and Budget Management Act, 2003 is a landmark piece of fiscal legislation that lays down a target-based framework for the management of Government finances, with a view to achieving long-term macroeconomic stability.

The Act originally prescribed the following two basic fiscal indicators: Fiscal deficit and revenue deficit. Fiscal deficit is “the excess of total disbursements from the Consolidated Fund, excluding repayment of debt, over the total receipts into the Fund (excluding debt receipts) during the financial year”.

Revenue deficit is “the difference between revenue expenditure and revenue receipts which indicates increase in liabilities of the Central Government without increase in the assets of that Government ”(emphasis added). An additional fiscal indicator, namely, effective revenue deficit, has been prescribed by an amendment to the FRBM Act by the Finance Act, 2012. Effective revenue deficit has been defined as the difference between “the revenue deficit and the grants for creation of capital assets”.

Grants for creation of capital assets are defined as “the grants-in-aid given by the Central Government to the State Governments, constitutional authorities or bodies, autonomous bodies and other scheme implementing agencies for creation of capital assets which are owned by the said entities”.

The amendment confers a statutory status on the concept of effective revenue deficit which had already featured in the Central Budget 2011-12. Against the FRBM Act target of elimination of revenue deficit by March 2009, the proposed amendment seeks to eliminate effective revenue deficit by 2015.

REVENUE-CAPITAL DIVIDE

Effective revenue deficit is intended to cure the distortions caused by large-scale transfers to other entities for the creation of capital assets (which must necessarily be classified as revenue expenditure in the Central budget and accounts, since the ownership of such assets does not vest in the Central Government).

That grants to other entities for the creation of capital assets was unequivocally recognised by way of the explicit reference to the ownership of the assets in the definition of revenue deficit in the FRBM Act.

Nevertheless, the additional indicator has been justified on grounds of the strong federal structure of the country and the increased policy thrust on social sector spending, involving larger transfers to other entities, which supposedly have a significant component for creation of capital assets. This reasoning raises several concerns.

First, the Constitution recognises two types of expenditure: expenditure on revenue account and other expenditure (broadly understood as capital expenditure) and these must be separately shown in the Budget for approval of the Parliament. This Constitutional requirement of separate accounting of revenue expenditure and capital expenditure for Parliamentary approval has a purpose – it ring-fences capital expenditure and prevents it from being diverted for meeting expenditure on revenue account through executive orders. In other words, the Budget provision for capital expenditure must be utilised only to that end, or it shall remain unutilised.

Even so, the Central Government can utilise the provision originally earmarked for grants for creation of capital assets to meet other revenue expenditure by mere executive orders. This diminishes the financial supremacy of the legislature over the executive. It dilutes fiscal discipline as well. Second, the Budget documents provide very little information regarding the assets expected to be created by the grants to States. This reduces the transparency and carries the moral hazard of creative budgeting and window-dressing.

MGNREGA AND MPLADS

Third, the ordinary principles and procedures of defining capital expenditure do not reveal enough by way of creating capital assets. For example, out of a budget of Rs 33,000 crore for MGNREGA scheme, an amount of Rs. 31,659 crore has been shown as grant for creation of capital assets.

The MGNREGA scheme is demand-driven, and there can be no pre-budget information or scrutiny of capital assets expected to be created by Central Government grants; it is also location-specific, requiring employment to be provided within a specified location, even if such employment may not result in creation of capital assets.

The MGNREGA funds can be accessed for rural housing under the Indira Awas Yojna, for construction of toilets in private houses and in specified circumstances for works on beneficiaries’ own lands; thus the ownership of such assets may not vest even in the transferee entities to which the Central funds are provided. The amounts are spent on small works which may not last more than one or two years and many of these works would ordinarily not qualify as capital assets.

Some of these considerations also apply to capital assets expected to be created out of MPLADS provisions, the entire amount of which has been classified in the budget as grants for creation of capital assets. These two schemes alone account for more than 20 per cent of the budgeted grants for creation of capital assets.

MONITORING NORMS

Fourth, large amounts of Central releases remain unspent with the implementing entities, sometimes because of the inherent requirements of schemes like the MGNREGA, for which at least three months’ fund requirement is provided in advance. Since the amount is not actually spent, it results in virtual expenditure in the Central accounts, and the so-called capital assets remain only on paper. Fifth, there are instances of large-scale diversion of Central Government grants to meet other expenditure by the recipient entities, and such diversion remains unknown to the Central Government. The Government’s Central Plan Monitoring Scheme System announced in 2007-08 continues to be a work-in-progress.

However, unless the foregoing concerns are satisfactorily addressed, the amendment may only lead to a lowering of the bar of fiscal rectitude.

It is necessary that the principles of classification of grants as grants for capital assets are clearly defined and rigidly observed and the Central Monitoring Systems are appropriately strengthened. Any transfer of budget provisions for creation of capital assets to other revenue heads shall be reported to the Parliament.

(The author is a former Deputy Comptroller and Auditor-General of India.)