A persisting obsession

Print edition : March 13, 1999
The Finance Minister's obsessive concern about the fiscal deficit is merely a continuation of a tendency that has characterised fiscal policy since the launch of IMF-style reform in the country.

OTHER than projecting an obsessive concern with the fiscal deficit, Finance Minister Yashwant Sinha has been able to offer little to match the hype and the expectations created by the media about the Budget. He has not merely manipulated a remarkably low fiscal deficit of 4 per cent of GDP in his Budget for 1999-2000, but promised to do away with the revenue deficit and bring the fiscal deficit down to less than 2 per cent in three years' time. As he reportedly informed a post-Budget meeting with representatives of the Federation of Indian Chambers of Commerce and Industry (FICCI), the principal aim of his second Budget was to cut the huge fiscal deficit. This obsession with the fiscal deficit, even in a year in which persisting recession in the industrial sector has set off demands for higher government expenditure, is merely a continuation of a tendency that has characterised fiscal policy since the launch of International Monetary Fund-style reform.

According to the Finance Minister, "the fiscal and revenue deficits of the Centre and the States are... undermining our ability to bring down domestic interest rates, stimulate investment and growth, curb inflationary potential, generate resources for priority, non-interest expenditure needs and raise exports." Put simply, most of India's economic problems can be traced to one original sin. But the mechanism by which the deficit impacts on such a wide range of problems, including India's disastrous post-liberalisation export performance, is unclear.

IT is useful, however, to clear the air on at least some issues. To start with, it bears repetition that if food stocks are adequately large and industry is characterised by unutilised capacity, resort to such financing need not be inflationary. Further, if deficit-financed expenditure is diverted towards capital expenditure which eases supply-side bottlenecks, even the existence of at least some such bottlenecks need not constitute an inflationary barrier to deficit spending or a reason to make deficit reduction the principal concern of the fiscal agenda. Finally, if foreign exchange reserves are comfortable, as the Government claims they are at present, even shortages of tradables do not constitute an inflationary danger in the wake of deficit-financed spending, since such shortages can be eased by resorting to imports. Thus, an inflationary spiral need not be an automatic and inevitable outcome of deficit financing, as the experience with recent budgets have shown.

Nor can high interest rates be attributed to the fiscal deficit. It can in fact be argued that the Government's decision to prevent the Centre from financing a part of the deficit on its Budget with the issue of short-term Treasury bills, so as to curb money supply growth, was in the first instance aimed at raising interest rates to attract capital inflows in the wake of the 1991 balance of payments crisis. One consequence of the abolition of the practice of the central government issuing ad hoc T-bills to finance its deficit was the fact that the Centre had to resort increasingly to open-market borrowing to garner resources to sustain its expenditures. During the period 1993-94 to 1995-96, when industry witnessed a boom triggered by the pent-up demand for domestically produced, import intensive commodities such as automobiles and consumer durables, this presence of the government in the market for credit did sustain high interest rates.

But with the onset of recession, banks have been flush with funds, resulting in an easing of interest rates even when banks were holding government securities far in excess of the statutory requirements. In this period, the Reserve Bank of India (RBI) has actually been engineering a reduction in interest rates with the aim of stimulating an industrial recovery. The most recent instance of this is the immediate post-Budget decision of the RBI to cut the bank rate from 9 to 8 per cent and the repo rate (or the implicit rate at which banks and institutions can park securities sold at a discount with the central bank with the promise to repurchase them in a specified period of time) from 8 to 6 per cent. It has also announced a reduction in the cash reserve ratio for banks from 11 to 10.5 per cent, thereby releasing liquidity to the tune of Rs.3,400 crores. Thus, both the initial post-reform high interest rates and their subsequent reduction have been engineered by the central bank, rather than being driven by the fiscal deficit in the Centre's Budget.

There is, of course, a medium-term danger resulting from large and persisting fiscal deficits. Since such deficits by definition are financed through borrowing, they result in an increase in the interest and repayment burden on the Budget. Inasmuch as the spending associated with such deficit financing does not result in an increase in the revenues of the government, these burdens foreclose a part of available government resources, restricting the fiscal manoeuvrability of the state. Over time this could also result in a growing revenue deficit, requiring borrowing to finance increased current (including interest) expenditures. Thus a sustainable deficit would be one that stimulates economic activity of a kind that generates or can generate additional tax revenues for the government. It is for this reason that deficits which are used to finance current rather than capital expenditures are considered by many people to be far less defensible than deficits that are used to finance capital expenditures.

The difficulty is that the 1990s obsession with the fiscal deficit in India is neither concerned with what budgetary deficits are used to finance or with the question of the sustainability of a given level of deficit. Fiscal deficit reduction has become a virtue in itself, and budgetary analyses are restricted to how far Finance Ministers are able to ensure that reduction without "offending" different lobbies. One consequence has been that all discussion of the direction that fiscal policy should take or of the vision that should or does underlie the budgetary exercise is given less importance than it deserves, or even ignored.

THE dominance of this perspective has had three consequences this year. To start with, in the midst of what now appears to be a prolonged recession, Finance Minister Yashwant Sinha's effort to stimulate a recovery has been restricted to providing incentives to housing investment, providing incentives to investments in mutual funds that would in turn invest in the stock market, and getting the RBI to engineer a reduction in interest rates. Expenditure to provide a stimulus to demand has been abjured in order to facilitate a process of deficit reduction.

Second, since interest payments are an unavoidable commitment, defence expenditure is a holy cow and expenditure on administration is difficult to curtail, the burden of adjusting the revenue deficit is to fall on subsidies, especially those on food and fertilizers. And, third, in their eagerness to show a lower fiscal deficit in his books, Finance Ministry officials have resorted to statistical jugglery, almost bordering on fraud.

The last of these consequences is most visible in the Government's decision to provide a range of figures on the revised fiscal deficit to GDP ratio for financial year 1998-99 and the projected fiscal deficit to GDP ratio for 1999-2000.

Two means have been used to deliver that range. First, the use on occasion of the old series on GDP with 1980-81 as base and on other occasions of the new series on GDP with 1993-94 as base, which inflates the GDP figure quite substantially relative to the old series. It should be obvious that the use of the new series by increasing the size of the denominator would for a given fiscal deficit yield a lower fiscal deficit to GDP ratio. The second means employed is to choose to leave out of the capital receipts included in the Budget that component of small savings collections that earlier used to accrue to the Centre to be lent to the States, on the ground that it has little to do with the Centre's activities and that the Centre has merely undertaken a "Treasury-type" transaction in the case of such funds. Since by definition all capital receipts, except loan recoveries and receipts from disinvestment, are included in the fiscal deficit since they constitute borrowing, the newly adopted practice substantially reduces the fiscal deficit. The projected reduction for 1999-2000 amounts to Rs.25,000 crores, or 1.3 per cent of GDP.

While the use of a new (and reportedly better) GDP series with a more recent base cannot be objected to, the decision to leave out of the Centre's Budget a large chunk of small savings collections is less defensible. If anybody is concerned with the fiscal deficit, then the concern should be for the size of the combined fiscal deficit of the Centre and the States. The anomaly lies in speaking of the fiscal deficit of the Centre alone. But since Yashwant Sinha is keen to show himself in better light, presumably to the IMF and the media, he has chosen to narrow even further the notion of fiscal deficit which comes up for scrutiny at budget time.

THE net result is that both the Budget speech and the Budget documents are filled with figures that by definition are incomparable. In order to assess where exactly the fiscal deficit stands as projected for 1999-2000, when compared with the deficit for the previous years, a closer look at the figures becomes necessary. Such scrutiny reveals four facts. First, the change in the base year for the GDP series results in a 0.5 to 0.7 of a percentage point difference in the fiscal deficit to GDP figure for 1998-99 and a 0.4-0.5 of a percentage point difference for 1999-2000, the variation depending on the definition of the fiscal deficit used. Secondly, a change in the notion of the fiscal deficit results in a 1.5 to 2.3 percentage point difference in the fiscal deficit to GDP ratio for 1998-99 and a 1.3 to 1.4 percentage point difference of 1999-2000, depending on the GDP series used. Thirdly, moving from the old to the new versions of the fiscal deficit to GDP ratio reduces it from 6.5 per cent to 4.4 per cent (or by 2 percentage points in 1998-99 and from 5.8 per cent to 4 per cent (or by 1.4 percentage point) in 1999-2000. Fourthly, if we use comparable figures to assess the change in the fiscal deficit to GDP ratio for 1998-99 and 1999-2000, the change amounts to a decline from 6.5 per cent to 5.8 per cent (or by 0.7 percentage points) based on the old definition and from 4.4 per cent to 4 per cent (or by about half a percentage point) based on the new definition.

The conclusion is clear: Yashwant Sinha's effort to project a lower fiscal deficit is successful only by redefinition, since largely as a result of that the fiscal deficit to GDP ratio falls from 6.5 per cent to 4 per cent. The actual reduction has been only marginal, since a comparison of figures brings the deficit down from only 4.4 to 4 per cent of GDP.

Moreover, if Yashwant Sinha is convinced about the definition of the deficit he has now adopted and about the validity of the new GDP figures, then the size of the fiscal deficit in the Budget is by no means alarming. Hence, there is no reason why he should make deficit reduction the principal task of his Budget. The fact that he has chosen to do so suggests either that he has little by way of a programme to implement or that he is not convinced by the jugglery resorted to by the mandarins in the Ministry.

Whatever be the reason why he has chosen deficit reduction as his principal plank, it is clear that the Finance Minister has only been marginally successful, if at all. This, however, is not because of a lack of effort. In fact, with the aim of reducing the fiscal deficit he has resorted to a number of measures. The pre-Budget hikes especially in the administered prices of fertilizer and food distributed through the public distribution system constitute the first such measure.

A second measure is the divestment of government equity in successful public sector enterprises to the extent of Rs.9,000 crores during this financial year and a budgeted Rs.10,000 crores during the next financial year. Third, the mobilisation of a significant volume of additional resources, of around Rs.9,000 crores from indirect taxes such as excise (including that on universal intermediates like diesel) and customs duties and a surcharge on income and corporate taxes. And, finally, a curtailment of capital expenditures in real terms, with extremely adverse consequences for industrial and agricultural growth.

Of these, the large receipts from public sector disinvestment is a fudge with disastrous growth consequences. Given the poor state of the stock market, "disinvestment" does not mean privatisation, since there are few buyers even at low prices.

Resources are to be garnered by virtually stealing surpluses from the public sector, by forcing public sector enterprises to use their surpluses to buy back the government's equity in their own capital or that of other PSEs, rather than invest them in modernisation or expansion. By weakening them in this manner, in a period of increased competition owing to liberalisation, they are being forced to perform poorly and sell out to private operators at a later stage. In addition, the government is to guarantee borrowing by weak PSEs from banks or through bonds issued to workers to generate finances to pay voluntary retirement or retrenchment benefits, thereby encouraging their "restructuring" by mortgaging the future. Since it is unlikely that these enterprises would be able to bear the burden of such debt, this appears to be a way to prepare them for closure in the near future. Thus the worst forms of public sector restructuring are being introduced through the back door.

IN addition to transferring the burden of the Centre's deficit on to PSUs, the Government has made extremely optimistic estimates about revenue collections in the coming financial year. From estimates of growth in GDP and in tax collections under different heads in 1998-99 (actuals) and 1999-2000 (projected), it can be seen that while GDP growth is expected to decline from 14.07 per cent in 1998-99 to 12.57 per cent in 1999-2000, income tax collections in 1999-2000 are expected to grow at least as fast as this financial year, while customs and excise duty collections are expected to increase at much higher rates despite the fact that there are no signs of reversal of the recession in the industrial sector. Not all of this increase is attributed to additional resource mobilisation (ARM).

Estimates of estimated tax collections without ARM measures indicate that sheer buoyancy of indirect taxes is expected to make them grow at much higher rates than in the financial year that is coming to a close.

Unfortunately for the Finance Minister, despite all this, and despite a sharp reduction in subsidies relative to 1997-98 as well as rather optimistic projections about expenditure growth under other heads, he has not made much advance with regard to the fiscal deficit, forcing him to save face through dubious statistical means.

The Finance Minister probably expects that the burdens he has imposed in order to notch up a marginal decline in the fiscal deficit would be neutralised by the growth stimulated by new housing starts and lower interest rates. But given the intensity of the recession facing the industrial sector, it is unlikely that lower capital costs and easier credit would neutralise the persistence of the principal factors underlying the current recession: import competition and the state's abdication of its earlier role of providing through its investments a major stimulus to industrial growth.

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