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Business News/ Opinion / Fiscal tasks for the next government
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Fiscal tasks for the next government

The key is to reinvigorate investment through good fiscal management

Illustration: Jayachandran/MintPremium
Illustration: Jayachandran/Mint

The final fiscal report of the second Manmohan Singh government was presented by finance minister P. Chidambaram during the interim budget on Monday. There was good news. The fiscal deficit for the year ending March will be less than targeted. The current account deficit has also shrunk in recent quarters. What this means is that the Indian economy is now in a far better position to handle the next bout of global instability—and a far cry from the situation in July when the twin deficits almost sent the rupee into free fall.

Chidambaram deserves credit for the improvement in the fundamentals despite the obvious criticisms that some of the fiscal discipline is an illusion created by clever accounting while the current account looks better because gold imports have been driven underground into the hands of the old smuggling networks. Yet, there can be little doubt that the finance minister has done well in his third tenure in charge of national finances.

Chidambaram took charge on 31 July 2012, when the government seemed to have lost control over its finances. A panel headed by economist Vijay Kelkar had not pulled any punches when it warned in a report published a few weeks later that India stood of at the edge of a fiscal precipice. Chidambaram has done well to prevent a further deterioration in public finances despite the fact that tax revenues have been weak in a slowing economy. He has thus forced some sort of spending discipline on a government that should be remembered for its notorious profligacy.

These recent successes should in no way let the current government off the hook for mismanaging national finances after 2009. It had joined governments across the world for a coordinated fiscal stimulus to support domestic demand after the global financial crisis almost kayoed the global economy. The problem is that this stimulus was never withdrawn despite several public promises.

The second Manmohan Singh government has missed several successive targets for fiscal consolidation laid out in the medium-term fiscal plans tabled during various budgets, the recommendations of the 13th Finance Commission and the road map outlined by the Kelkar panel. In short, fiscal policy statements had lost credibility. Investors refused to believe government statements about its noble intentions to bring public finances back into shape.

The fiscal stimulus was based on a boost to demand at a time when the supply side froze because of policy tangles. The natural result of this was high inflation once the economy recovered. The Reserve Bank of India also failed to withdraw its monetary stimulus in time; inflation peaked in March 2010 while policy rates peaked only in October 2011. Part of the excess domestic demand also spilled over into the external sector. The current account deficit widened to levels not even seen during the 1991 crisis.

The current government has drifted far away from the deficit targets put down in the landmark Fiscal Responsibility and Budget Management (FRBM) Act of 2003, despite the recent success in capping the deficit problem. Chidambaram said in the course of his budget speech that the next government should aim for a fiscal deficit of 3% of gross domestic product in 2017. That will be nine years behind the original FRBM target, an indication of how far India has floated away from safe shores.

The next government will inherit an economy that has lost its dynamism. The key to a sustainable economic recovery is getting investment activity back on track. And good fiscal management will be the key task. The last act of this government should be a useful cue for the first act of the next government.

There are two big issues here. First, a lower fiscal deficit will make it easier for the Indian central bank to reduce interest rates once it gets inflation down. Second, there should be a concerted effort to switch the focus of government spending from subsidies to asset creation. Both can be addressed by a new fiscal law to replace the one that was dumped in 2009.

The FRBM law had two important provisions: a low fiscal deficit as well as a zero revenue deficit. What the latter means is that the government should borrow only to fund asset creation; spending on salaries, subsidies, interest payments, etc., should be funded from current revenues. The next government should move quickly to get a new version of the FRBM law in place.

The economic mismanagement of the past few years has several ingredients besides fiscal profligacy: lack of reforms, policy instability, poor governance. The journey out of the trough may not be a short one, but the full budget that is to be presented after the coming general election should build on the recent fiscal success to further strengthen national finances.

Will the next government adopt the path of fiscal discipline?

For full budget speech, click here

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Published: 17 Feb 2014, 12:10 PM IST
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