Days for effective revenue deficit could be numbered

Though there was no such announcement in the Budget, the govt is now considering scrapping the concept

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Amid the proposal for a larger devolution of untied funds to states, the Union government is considering doing away with the concept of effective revenue deficit (ERD). Though the concept was not scrapped in Budget 2015, as suggested by the 14th Finance Commission, a decision could be taken in due course. 

ERD, basically, is revenue deficit minus expenditure on capital generation for the Centre’s grants to states. The concept was mooted in 2011-12 by Pranab Mukherjee, then the finance minister, through an amendment to the Fiscal Responsibility and Budget Management (FRBM) Act. This was done as adhering to the previous Finance Commission’s recommendation of zero revenue deficit by 2013-14 and surplus by 2014-15 appeared difficult.

The 14th Commission suggested the government scrap this concept from 2014-15. The Budget for the year, though, not only retained it but gave a fiscal consolidation road map with ERD targets up to 2017-18.

In its report to the government, tabled in Parliament and made public last month, The Commission says: “We recommend the Union government consider making an amendment to the FRBM Act to omit the definition of effective revenue deficit from April 1, 2015.”

In a document presented under FRBM Act, the finance ministry said: “... grant-in-aid for capital expenditure is subsumed within untied funds transferred to states. Against the backdrop of such changes, the efficacy of ‘effective revenue deficit’ as a measure to capture end-use of resources needs critical examination.”

It also reminded that the ministry had, in its action-taken report, said the recommendation of the 14th Finance Commission would be examined. 

A finance ministry official said he saw positive and negative points in both keeping and doing away with ERD but the larger issue was fiscal consolidation. 

Along with fiscal deficit, the government has also deferred the target of having zero ERD —a year later than that proposed in the road map given by P Chidambaram, Finance Minister Arun Jaitley’s predecessor. However, when compared with the original road map of 2011-12, when the concept was first used, the new road map stands deferred by two years.

According to the original plan, ERD was supposed to come down to zero by 2014-15. But Chidambaram’s fiscal consolidation plan targeted achieving it by 2015-16. Now, in the Budget, this has been deferred to 2016-17, and is to be retained at that level in 2017-18.

The 14th Commission wanted to scrap ERD because the Constitution has provisions only for revenue and capital expenditures.

“Under the Constitution, there are only two categories of expenditure — the one on the revenue account and that broadly expressed as capital expenditure. Artificially carving out revenue account deficit into effective revenue deficit... leads to an accounting problem and raises the moral hazard issue of creative budgeting,” the Commission had said. 

The Commission had recommended increasing devolution to states in the form of tax and grants to 42 per cent from the current 32 per cent. In terms of overall transfers, however, the change might only be of two-three percentage points over the existing allocations. But the new set-up gives much more untied fund to states than earlier.