War of words breaks out between CEA, other members of FRBM panel

FRBM panel disagrees with CEA, a fellow member, on why and how to address deficits

Chief economic advisor (CEA) Arvind Subramanian has given a dissent note to the recommendations given by the panel reviewing the existing Fiscal Responsibility and Budget Management (FRBM) law. He suggests a focus on the primary deficit, rather than the “multiple” goals the others recommend. The primary deficit is defined as the fiscal deficit after excluding interest payments by the government.

Probably for the first time in a panel report, the others — former finance secretary Sumit Bose, Reserve Bank governor Urjit Patel, National Institute of Public Finance and Policy chief Rathin Roy and former expenditure secretary N K Singh (chairman) — gave a rejoinder to the dissent note of a fellow member.

The committee recommends the Centre aim to bring down its debt to 40 per cent of the country’s gross domestic product (GDP) by 2022-23. To do so, cut the fiscal deficit from three per cent of GDP in 2017-18 to 2.5 per cent by FY23. And, keep the deficit at three per cent of GDP for three years starting 2017-18.

Also, the revenue deficit should be targeted to come down from 2.05 per cent of GDP in the current financial year to 0.8 per cent in 2022-23. The combined Centre and states' debt should be targeted to come down to 60 per cent of GDP by 2022-23, the committee said.

To these main findings, the CEA has said: “There are multiple targets on stock, flow and composition, diffusing the focus, complicating communication and comprehension, and risking non-compliance.”

Subramanian said the targets of the majority are themselves arbitrary. “A 60 per cent debt-GDP rule cannot command broad consensus. Nor can a revenue deficit target of 0.8 per cent of GDP. And, the medium term fiscal deficit target of 2.5 per cent of GDP is based on a conceptual framework, is unrelated to the debt objective and is based on calculations that are hard to justify.”

Rather, Subramanian suggested a “simple and consistent architecture” that reflects India's fiscal realities of the past and its prospects for the future. And, this is based on only one target — a steady glide path that eliminates the primary deficit of Centre and states within five years.

“This would ensure a declining debt trajectory, which would reassure investors and ensure India's debt remains sustainable even when the debt dynamic turns less favourable in the medium term,” he said.

He also questions the panel's recommendation on the fiscal deficit path. “This follows an old sequence of cut sharply, pause and cut again, that is difficult to explain or justify.” This path, Subramanian said, is inappropriate in the short run because of cyclical considerations. And, insufficiently ambitious in the medium term in placing India's debt on a sustainable long-term trajectory.

The majority have also recommended an “escape clause”, whereby the targets could be deviated from if GDP growth is higher or lower by three percentage points than a recent trend. The CEA said this would lead to pro-cyclical policies, rather than counter-cyclical ones.

There are stronger reasons why the revised FRBM should eschew a revenue deficit rule...it makes little sense to place arbitrary limits on the share of the revenue deficit in the overall deficit...Adding a revenue deficit rule would further add to complications that already stem from having both a debt and fiscal deficit rule...

Arvind Subramanian, Chief economic advisor

We disagree...

In their rejoinder, the other members have tried to establish through mathematical example that a declining primary deficit is neither necessary or sufficient for debt ratios to decline.

And, that running primary surpluses is a necessary but still not sufficient condition for the debt to GDP ratio to decline. “Even if a country generates very high primary surpluses, if its stock of debt is large, it will not be enough to offset the interest payments, and the debt path can be explosive.”

And, that a zero primary balance (combined for Centre and states) poses a serious issue. It basically implies that it is not optimal for the government to borrow for any additional non-interest expenditure. This, the majority said, defied economic logic. There is an incentive for capital-scarce countries, especially those with infrastructure gaps like India, to borrow and invest, as the marginal product of capital is higher than the cost of borrowing.

The argument that the government could simply ignore the revenue deficit path implies a judgment on the credibility of the government which this committee does not share with the author of the dissent note...This committee...cannot dismiss the credibility of this govt as light-heartedly as the author of the dissent note seems to

Other members

The members also said while the dissent emphasises counter-cyclicality, in that revenues garnered in good times should not be spent but saved, it at the same time considers zero primary balances as optimal. Which implies exactly the opposite, that any additional revenues should be completely spent.

They add that primary balance is not a concept easily understood even by economists and would be impossible to explain to an ordinary citizen. Also, that is no other nation of the G20 grouping, and in fact in no other large country, was a permanent fiscal rule on primary balance embedded in their legislation.