Steps for credible fiscal roadmap

The Finance Commission is set up under Article 280 of the Indian Constitution once in every five years, to recommend the sharing of the net divisible proceeds of Union taxes between the Central government and the States and also the grants-in-aid of revenues of the States.

The latest Fourteenth Finance Commission, set up in January, is required to submit its report by October 2014, with its recommendations covering the five years from April 1, 2015. The special task added to the terms of reference of this Commission is a review of the state of finances of the Centre and the States, and proposing measures for a stable and sustainable environment consistent with equitable growth. That includes suggestions for amendment of the Fiscal Responsibility and Budget Management Act (FRBM) of 2003.

The preparation of a credible fiscal roadmap is possible only if the following criteria and steps are taken into consideration:

Austerity limits

Austerity or spending cuts in themselves are not a solution. An ad hoc cut of 10 per cent in non-Plan expenditure routinely prescribed by the Ministry of Finance will not do. What is needed is optimum utilisation of scarce resources that have alternative uses. It requires a fundamental review, so as to lead to a weeding out all non-developmental, non-priority and unproductive expenditure, while focussing on growth-oriented spending.

The current ‘Plan’ and ‘non-Plan’ classification distorts the picture and requires review in particular. It will be useful to check if the zero-based budgeting laid down in the Budget Manual to facilitate such a review has been of any practical use. The problem of a large number of overlapping Plan schemes has to be addressed.

Subsidies, likewise, place a huge burden on the Budget. Some major issues necessary to be addressed are lack of correct estimation with broad-based assumptions, understatement of expenditures, non-examination of costs for undertaking possible reductions, not fully dismantling the administrative mechanism for fuel subsidies, and non-targeting of beneficiaries.

Accrual accounting for subsidies may help to highlight the full expenditure for the year. Of course, the Budget deficit will be on the basis of cash expenditures.

Output/Outcome budgeting

It is not enough to simply budget for priority expenditures. Efficiency and effectiveness of such expenditures are equally vital. The output and outcome budgeting, introduced in 2005-06, has to be examined in depth to check the actual outcomes resulting from this new fiscal monitoring and management tool.

The remedial action taken as a result of implementing such budgeting must also be ascertained. There are many problems, for example, in evolving suitable performance indices and gathering data on them, especially with regard to outcomes of a non-financial nature.

The above approach has been in vogue in many OECD countries, such as the US and Australia. Their experience has to be gone into for lessons to us. The Australian National Audit Office (the country’s Auditor General) in a report in 2011-12 has given a useful assessment of development and implementation of key performance indicators.

It is also worth examining the use of output/outcome budgeting for directing transfer of Central plan assistance to State/district-level autonomous bodies and implementing agencies.

Monitoring public private partnership (PPP) projects for cost control and outcome poses special problems, including that of data access. Delay in implementation of capital projects in vital sectors deserves scrutiny, in order to identify the reasons and taking timely remedial action. Further, the burden of public sector undertakings (PSUs) on Government budget in the form of grants and investment support has to be reduced. PSUs should be made to generate more internal resources, while many of them deserve to be closed – especially those already declared as sick and still lingering on.

Disinvestment of shares cannot be a cure for the Government’s fiscal illness. It is desirable to prevent pressure on other PSUs to subscribe to divestment offers when no bid from the public is forthcoming (the Life Insurance Corporation has been regularly forced to do this in recent times).

The Railways, a departmental undertaking, is in a financially precarious position with unacceptably high operating ratios. Urgent steps are necessary to improve operational efficiencies and generate internal resources, rather than support from the general Budget, for funding important infrastructure projects. Cross-subsidisation of passenger fares by higher freight charges should end, especially in times of commodity inflation. A mechanism has to be devised to free tariff fixing from political compulsions.

FRBM Act

On the revenue front, specific time-bound steps have to be taken to bring unaccounted money into the official tax net.

Tax exemptions and deductions take away more than half of gross tax revenue. Such huge outgoes do not even figure as an item in the Budget.

This is due to the Budget papers only showing the Government’s net tax revenues. In other countries, exemptions and deductions are treated as tax expenditures, to be approved by the legislature and bringing them under scrutiny. Output/outcome budgeting will hopefully help weed out unnecessary and irrelevant concessions. It also emphasises the need for statutory audits of fiscal stimulus packages announced from time to time.

With regard to amendment of FRBM Act, there are some important suggestions to be made, including on the terms of reference of the Finance Commission. Fixing deficit targets as percentages of GDP can be reviewed.

A Fiscal Code of Conduct should be drawn up in the light of poor fiscal track record in recent times, with the focus more on achieving deficit target numbers and not on the quality of deficit reduction. A medium-term fiscal plan or roadmap should reflect the effect of specific reforms on the fiscal issues detailed earlier, while being transparent with all assumptions. This should be accompanied by a Fiscal Responsibility Index with the relevant parameters to monitor implementation of the medium term fiscal plan.

There has to also be some means of providing the Central government sufficient leverage to control the deficits of State governments. Parliament and the State legislatures should set aside time for periodically reviewing the implementation of the FRBM Act. Steps are necessary to ensure connectivity between fiscal and monetary strategies.

(The author was Joint Secretary in the Union Government and IMF Budget Adviser.)