Dire need to improve govt expenditure quality

The Reserve Bank of India (RBI) on Tuesday raised the red flag on the high fiscal deficit. Highlighting the adverse effect this would have on economic stability, Governor D Subbarao said the Centre needed to curtail borrowings and spend on creating real assets.

In its third quarter review of the monetary policy, the central bank read the Riot Act to the government, expressing displeasure over the means it was using to bridge the gap between revenue and expenditure. It expressed its displeasure over the government’s dependence on raising funds through disinvestment in public sector companies and receipts through sale of spectrum to bridge the gap. The third quarter monetary policy review states: “Fiscal consolidation based on one-off receipts is not sustainable.”

The government may have enjoyed the proceeds from divestment. However, that cannot be a long-term solution to meeting the fiscal deficit. Fiscal consolidation is important for several reasons in any economy. First, monetary policy can deal efficiently with an inflationary situation when the fiscal situation is under control. When the government’s deficit is low, the central bank can deal with rising inflationary pressures. High fiscal deficit, on the one hand, makes inflation management difficult and also crowds out private sector borrowing on the other. In addition, commodity price developments like rising global crude oil prices pose significant risks for fiscal consolidation in the year ahead as the spend on subsidies will go up substantially.

If the government decides not to pass on the increase in petroleum product prices to consumers and farmers, it will have to make adequate budgetary provisions to meet the gap. This will constrain its ability to reduce the fiscal deficit. On the other hand, if it passes on the price rise to consumers, then it might undermine fiscal management and make it impossible to tame inflation.

The government may succeed in raising receipts through tax buoyancy and one-off sources like spectrum sale, but the real measure of fiscal consolidation lies in improving the quality of expenditure. If the government is able to commit more resources in generating real assets through capital investments, it will help deal with some of the bottlenecks that contribute to supply-side inflationary pressures. In other words, if the government invests in improving agricultural productivity, then it may go a long way in taming prices.