Coping with fiscal stress

Published : Nov 22, 2002 00:00 IST

Specific remedies to deal with the growing crisis in public finances, which spells rising debt and shrinking investments in essential services, elude the Conference of Chief Ministers.

GENERIC agreement on the need for "tough measures'' to tackle the growing crisis in public finances was the easy part. But if the purpose of the Conference of Chief Ministers convened on October 18 by the Prime Minister and the Union Finance Minister was to go beyond a reaffirmation of this verity, specific remedies remained elusive. Prime Minister Atal Behari Vajpayee is known to have remarked recently that disinvestment was the only vehicle moving through the policy jam of economic reforms. With that source of solace also having dried up, in part because of the unseemly rush to transfer revenue-earning assets to private hands, the Central government has chosen to initiate a serious policy dialogue with the States. But the outcome has been a renewed impasse.

The Conference of Chief Ministers was conducted in far from auspicious circumstances. Early in September, a global credit rating agency downgraded India's rupee debt to junk status, effectively signalling that it was not a safe investment destination. The Finance Ministry put on record its disdain for this assessment, but had few convincing rejoinders to the underlying considerations. Since 1990-91, the debt-GDP ratio for the Central government has grown from 55.3 per cent to 58.4 per cent, and for the States from 19.4 per cent to 25.6 per cent. Netting out the debt incurred by the States to the Centre, the combined liabilities of the Central and State governments today stand at over 70 per cent of gross domestic product (GDP), against a figure of just over 61 per cent when the "reforms'' process began. Various developing country economies in the past few years have begun to manifest the symptoms of financial meltdown at similar levels of national indebtedness.

This picture of growing debt is also a story of shrinking investments in essential services such as health, education and social welfare domains in which the States have to fulfil a considerably larger share of public expectations than the Centre. Interest payments by the State governments, which amounted to less than Rs.10,000 crores in 1990-91, could be in excess of Rs.70,000 crores according to the budgetary estimates this year. From less than 14 per cent of total revenue receipts of the States when the reforms began, interest payments now could be close to 25 per cent.

The Chief Ministers had before them a menu of options to deal with the situation, most of them of a contingent nature designed to alleviate the immediate symptoms of fiscal stress. A notable proposal was one for a rollover of the States' debt, with fresh receipts from various small-savings instruments being used to retire debt contracted at relatively higher interest rates in the past. The Finance Ministry has estimated that over the maturity of the loans, the States would stand to save a sum of Rs.37,000 crores in interest costs from this scheme.

Recent developments in the money markets also tend to give this proposal a certain appeal. On an average, the States pay an interest rate of around 8 per cent on market borrowings, against 11.5 per cent on loans from the Centre and 10.5 per cent on loans against small savings collections. Though market borrowings have been by far the most cost effective means to finance deficits, especially since 1996-97, the States are by law restrained from seeking excessive recourse to this option. Over the last decade, market borrowings have financed between 11 and 18 per cent of the States' gross fiscal deficit, and the figure in fact has been declining in recent times.

Till 1999-2000, small savings collections used to be channelled to the States by the Centre as part of its aggregate lending programme. Since that year there is a new accounting procedure under which the States issue special securities to an agency called the National Small Savings Fund (NSSF) to meet part of their borrowing requirements. This has meant that the States' dependence on Central loans has fallen, from between 40 and 50 per cent of the gross fiscal deficit in preceding years to an average of about 14 per cent.

This has also meant that the securities issued to the NSSF now account for the largest component of the States' borrowings. Reserve Bank of India (RBI) estimates put the dependence this year at over 38 per cent of the States' gross fiscal deficit. This also provides an instant clue to the problems inherent in the rollover proposal. Those States that are already borrowing heavily to meet revenue expenses are averse to seeing a part of the funds being diverted to retiring debt. They would face an acute liquidity crunch with the potential to force a default on the most routine expenses.

Recognising these difficulties, Finance Minister Jaswant Singh has referred the matter to another high-power committee. The fact that the initial proposal was itself worked out by a similarly empowered body with representation from Centre and States invests this decision with a certain sense of tedium.

The conference also debated a menu of expenditure curtailment proposals, including the freezing of dearness allowance and bonus and the commutation of pensions. States like Tamil Nadu and Haryana expressed themselves strongly in favour of a freeze of D.A. Agreement proved difficult on this issue for the obvious reason: no State government wants to risk the ire of a substantial section of the organised workforce. And no State wants to take the draconian step in isolation.

The RBI has estimated that the pension expenditure of the Central government grew from 3.8 per cent of current revenues to 7.2 per cent between 1990-91 and 2000-01. In the State budgets, it has found, pensions constituted the "fastest growing item of expenditure''. Apart from the purely economic dimension of pension reforms, governments, it would appear, are stymied by the questions of political legitimacy in a perceived reneging on commitments made to the growing numbers who are likely to join the ranks of the retired in the near future.

An element of concern over the reaction of the politically articulate salariat is also likely to checkmate any move to alter the rules governing provident funds. RBI estimates put the outstanding liabilities on account of provident funds at 15 per cent of the total liabilities of both the Central and State governments. With an interest rate of 9.5 per cent, these liabilities impose a heavier burden of servicing than market borrowings of equivalent maturity.

With a part of the corpus in these funds going into State government bonds, State Electricity Boards and financial institutions, the RBI has concluded, there is also an inherent default risk attached. Implicitly, the advocates of pension and provident fund reform have been pushing the case for a politically risky initiative today that could potentially forestall a far more expensive hazard in future. Clearly, though, the prevalent political dispensation does not have the requisite confidence in its popular legitimacy to push through the hard measures.

The single achievement of the Conference of Chief Ministers was in agreeing that the funds for Centrally sponsored schemes would be channelled through State governments rather than directly to the intended beneficiaries. The Finance Ministry accepted the States' plea that this would ensure better accountability in the use of funds, with the proviso that the requisite transfer from the State governments would take place within a defined time-frame.

Ultimately, the sub-text of the inconclusive conference related to the possible future directions that the "reforms'' process could take. Since the betting on supply-side economics began in 1990-91, the Centre's tax revenues as a proportion of GDP have declined from 10.2 per cent to under 9 per cent. In contrast, the States' revenues have held up rather well, increasing moderately as a proportion of GDP. In fact, the overall fiscal situation in the States would have been manageable but for the implementation of the Fifth Pay Commission recommendations in 1997-98, which plunged budgets sharply into the red. The question of who should bear the onus for repairing the alarming deterioration in the fiscal calculus is likely to emerge with greater salience in the months to come, with the States due to undertake a complex and potentially disruptive transition to a value-added tax (VAT) regime in March 2003.

Current estimates, made in accordance with a methodology evolved by the Finance Ministry, put the potential short-term revenue loss to the States from the transition to VAT in the region of Rs.14,000 crores. The States insist that this shortfall be fully underwritten by the Centre for a minimum of three years. The Centre has not committed itself on this, but is believed to be working on a partial neutralisation of revenue loss, possibly to the extent of 75 per cent in the first year of the transition. It then envisages that its commitment would be reduced in stages to 25 per cent in the third year, before being phased out entirely.

The central issue, though, is that the Central government, with its obsessive focus on the peripheral issues, is yet to show any aptitude to augment its fiscal capacity to deal with the range of challenges that it is likely to face soon.

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