India's fiscal experiments

The decline in economic growth and the expected revenue shortfall have raised the importance of the Union Budget 2020-21 considerably. The way the government manages its finances in the next fiscal year will significantly affect the Indian economy in the medium term. The government will need to take a call on whether it wants to support growth — which is expected to slip to 5 per cent in the current year — or contain fiscal slippage. The way the government manages expectations will also be crucial. At a broader level, the fiscal situation today looks more acute, though the challenge itself is not new. The government has often faced this dilemma. In this context, revisiting the recent history of fiscal management could be helpful. This is also a good time to reflect as exactly 20 years ago (January 2000), the E A S Sarma committee was formed to study various aspects of fiscal management, which led to the introduction of the Fiscal Responsibility and Budget Management (FRBM) framework.

 
Even after the economic crisis of 1991, which, to a large extent, was driven by high and unsustainable budget deficits, government finances were in an undesirable shape in the late 1990s. Thus, to contain the fiscal pressure, the FRBM Bill was introduced in 2000. It was eventually passed in 2003. The Sarma committee recommended a progressive reduction in fiscal deficit to 3 per cent of gross domestic product (GDP) by March 2006. It also proposed to eliminate the revenue deficit during the same period. Interestingly, the parliamentary panel, which reviewed the Bill, suggested that numerical targets should be removed, and revenue and fiscal deficit be maintained at “prudent levels”. The modified Bill had proposed a sharp reduction in fiscal deficit to 2 per cent of GDP. The fiscal deficit target of 3 per was notified in 2004.

 
The government managed to contain the fiscal deficit at 2.5 per cent of GDP in the fiscal year 2008. However, as is the case now, the headline number did not reveal the true picture. Off-budget bonds issued to oil companies alone were estimated to be worth over 1 per cent of GDP in 2006-07. Further, as highlighted by the N K Singh committee, which reviewed the FRBM Act, the Centre used the space created by ending financial intermediation for state governments — as recommended by the Twelfth Finance Commission — to increase grants to states. The Centre could have used this opportunity to consolidate its finances.

 

Besides, gains made in the high growth years were quickly reversed after the global financial crisis. The reported fiscal deficit expanded to 6 per cent of GDP in 2008-09, while the actual was much higher. Although some expansion was warranted because of the financial crisis, a large part of the slippage was on account of election-related spending. Fiscal profligacy continued and India lived way beyond its means for years. Predictably, unsustainable fiscal deficit resulted in high inflation and unmanageable level of current account deficit. India had a mini currency crisis in 2013. A committee formed under Vijay Kelkar to suggest a road map for fiscal consolidation noted (2012): “… Potentially, if no action is taken, we are likely to be in a worse situation than in 1991 for several reasons.” Differently put, a decade after the introduction of the FRBM framework, India was practically back to square one. Thankfully, the government got its act together and the change in political leadership did not change the fiscal priority, though reaching the 3 per cent fiscal deficit target remains elusive. In 2017, the Singh committee recommended a medium-term glide path to reduce the fiscal deficit to 2.5 per cent of GDP. This was aimed to reduce the Centre’s debt liability to 40 per cent of GDP by the fiscal year 2023. It also recommended a total public debt ceiling of 60 per cent of GDP, with the share of state governments at 20 per cent. India is unlikely to attain these targets anytime soon.

 
Therefore, it is clear that, though fiscal targets improved things on the margin — Budget numbers often don’t present the true picture — they have not instilled the desired discipline on the whole. Further, a significant expansion in deficit carries financial stability risks and is detrimental to growth. The 2013 mini-crisis is a case in point. Currently, the public sector is preempting practically the entire financial savings pool, affecting interest rates and economic activity in the private sector. Thus, at the present juncture, it is critical for the government to recognise fiscal limitations and risks associated with expansion. Further, since the credibility of the Budget is often questioned, its time to bring in an important missing part of fiscal reforms. India needs an independent fiscal council. The idea has been around since the introduction of the FRBM framework. It has been recommended by successive finance commissions and also the Singh committee. Depending on the terms, the council can independently assess government finances and periodically recommend the path for sustainable fiscal management. This will help infuse greater discipline, strengthen financial stability, and augment growth. Higher credibility will also reduce the element of risk and lower the government’s borrowing cost.