Country Egregious Memorandum

The message that the World Bank gives in its latest CEM is that India is facing serious fiscal imbalances. Coming after the last year's CEM which pronounced that fiscal imbalances of the Central Government have been stabilised, this is a curious re-reading of the macroeconomic situation "" within just one year. For compared to last year, the fiscal situation is better on every single count be it in comparison with the budget estimates available then or the revised estimates available now.

Without counterposing an alternative framework emphasising different, and perhaps more relevant, indicators of fiscal imbalance, start with what the Fund-Bank considers the mother of all deficits "" the fiscal deficit. Compared to last year, it is budgeted to be lower by almost 1 per cent of GDP in 1996-97. Revenue deficit in 1996-97 is budgeted to be Rs 4,000 crore less than in the 1995-96 budget. As a percentage of GDP it is 16 per cent less than the revised estimates. Most importantly, the primary deficit is less than half of what it was projected to be and just 18 per cent of what it has been revised for the last fiscal year.

 

This reduction has been possible by an improvement on the revenue receipts. For the first time in five years, the tax-GDP is inching its way up. Between 1989-90 and 1995-96 it had declined from 11.3 per cent of GDP to 9.8 per cent. It is now expected to be in the vicinity of 10.6 per cent.

On the expenditure side as well there have been notable gains. Non-interest expenditure at 11.5 per cent is the lowest in more than a decade. Analysing expenditure in terms of economic categories like final outlays, consumption expenditure and transfer payments gives an interesting picture: the wages and salaries bill of the central government has declined substantially. Most of this decline in current expenditures has come through a reduction in the wages and salaries of government administration. The decline of 0.7 per cent of GDP in the wage bill is not confined to the administrative departments alone. In the departmental undertakings also the share of wages and salaries has declined. The set of accompanying graphs show that different categories of current expenditure are currently at their lowest levels.

Surely, if these fiscal magnitudes are regarded as portents of a serious fiscal imbalance now, by the same logic it should have been characterised as a grave imbalance, if not a crisis, a year earlier.

Whatever the motivation to sound the warning bells, the CEM has given reasons as to why the fiscal imbalance has not been rectified. The most important, and the most obvious, reason is that interest payments on the Central government are close to 1 per cent of GDP higher than they were five years ago. That this should happen even as the primary fiscal deficit has declined secularly is due to the shift from deficit to debt financing. As the CEM itself points out, the reason is that the high interest rate regime which is a consequence of the liberalisation of financial markets, meant higher interest costs on the Central government debt.

According to the CEM, the second reason for the overall imbalance is that the states have not carried out any fiscal adjustment. It has been pointed out that the fiscal deficit of the states has hovered around 3 per cent. While statistically, this is correct, it fails to recognise an important specificity of the Indian federal system: state governments have virtually no control over the extent of fiscal deficit that they incur. Most of the borrowings are fixed by the Planning Commission when the central assistance to the state plan is finalised. What is under their control, and needs to be reversed, is the utilisation of the fiscal deficit. Most of it now goes into financing the revenue deficit rather than capital expenditure. But to a large extent this has become inevitable.

The Centre has cut a part of its fiscal deficit by reducing flows to the states. For instance, in the initial years of stabilisation, which the CEM considers to be meaningful fiscal correction, almost 50 per cent of the reduction in deficit was because of a reduced flow of transfers of states and the rest due to a reduction in capital expenditures.

Even in the current year, devolution has dropped to the lowest level in almost a decade. While this is because of a change in the composition of the Centre's tax revenues, it does impair the states' ability to finance its expenditures. Moreso, when the second stage of structural adjustment, relating to physical infrastructure and development of social services is just starting. These areas which are within the sphere of activity of the state governments will put additional burden on them.

If states are faced with a squeeze, either through a reduced devolution or other flows, how will they meet the requirements of the second phase of structural adjustment? By arguing explicitly for a reduction of central government financial assistance to the states the World Bank has clearly brought to the fore a basic conflict "" between stabilisation and structural adjustment.

Outlining the essential elements of a fiscal adjustment strategy, the CEM places right at the top the need to reduce the size of the central government. The basic policy prescription for doing so is a hackneyed one: keep the rate of new employment lower than the rate of retirement. On this basis the CEM estimates the decline could be as much as 0.2 per cent of GDP over the medium term. This can hardly be a solution. As it is, in the last decade or so the expenditure on wages and salaries has declined from 2.28 per cent to 1.55 per cent "" almost four times of what is aimed by the Bank. What has prevented an exponential growth of current expenditures in the face of increasing interest payments, is this decline in the wage bill.

This is a typical example of a basic problem with the CEM: to proffer generic solutions without caring either for the detail or the genesis of a problem. The CEM would be a much better report if the first part of its report was based on its statistical appendix.