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Govt should rein in spending, sell assets

Govt should rein in spending, sell assets
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First Published: Thu, Feb 25 2010. 10 17 PM IST

Updated: Thu, Feb 25 2010. 10 17 PM IST
New Delhi: The ambitious strategy for fiscal fitness outlined by the 13th Finance Commission, or TFC, is heavily dependent on the ability of the Union government to keep a tight leash on revenue spending and roll out an aggressive privatization programme over the next five years, even as it steps up capital spending that is necessary to support economic growth.
The commission, chaired by economist Vijay Kelkar, has set stiff debt and deficit targets that India has not achieved on a sustainable basis since the late 1970s. But these targets are not to be achieved by cutting capital expenditure as has been the wont of most recent governments in times of fiscal stress. This is especially true of state governments that slashed spending on key infrastructure to meet the goals set by the 12th Finance Commission.
Also See | TFC Recommendations (Graphic)
“I would prefer not to be constrained by a hard fiscal rule such as this road map if it comes in the way of spending on infrastructure projects,” says Rajiv Kumar, head of New Delhi-based think tank Indian Council for Research on International Economic Relations, citing the example of what state governments did in recent years. He also argues that the government should sell its equity in public sector firms that are either chronically loss-making or operate in competitive industries such as consumer goods and hotels, rather than privatize companies in strategic industries—selective rather than carte blanche privatizations.
Most economists agree that the current levels of government debt and deficits are too high and that India needs to consolidate its public finances. A lot also depends on what the government does with TFC recommendations.
“There are two stages in any fiscal consolidation: first, a road map and then actual government behaviour. The FRBM (Fiscal Responsibility and Budget Management) Act increased the awareness in the political system about fiscal issues and the risks they pose to economic growth,” says Rajeev Malik, economist with Macquarie Securities in Singapore. “But there have been execution problems and the results have not been great. So a lot depends on what the government now does about the goods and services tax, the direct tax code and subsidies.”
TFC has also recommended significant changes in the way the government does its budgeting as well as the sort of information it reveals in its annual revenue and spending statement in order to make it more transparent, comprehensive and forward-looking. As part of this exercise, it has suggested that India should have rolling budgeting in sync with the economic cycle rather than a discrete annual affair.
The chart alongside this story provides the key financial parameters that the Centre has to target over the next five years. TFC has called for a deep cut in India’s public debt ratio, not only compared with its current level, but also what was recommended by the 12th Finance Commission in 2004. It also says India should have a zero-revenue deficit by 2013-14, which in effect means the Union government should only borrow to finance capital expenditure.
Privatization plays a big part in these ambitious targets. Assuming that India’s nominal gross domestic product increases by 12% a year over the next five years, Mint estimates that the Union government will have to sell equity worth Rs3.8 trillion over the next five years to meet the targets in the TFC report.
These will help the government bring down its fiscal deficit to 3% of GDP even as capital spending rises to 4.5% of GDP. Kelkar had in a public lecture delivered in January come out in favour of a huge privatization push. “I am proposing that it makes a lot of sense for India to undertake this portfolio adjustment of public sector assets to switch from owning Air Indiato owning highways or public health infrastructure or augmenting ‘environmental capital’,” said Kelkar. “We may embark on disinvestment today, but we have to think about the end-game, which is privatization, where the government fully gets out of the picture.”
The recommendations submitted by TFC build on the various attempts over the past decade to impose binding fiscal rules on governments that have been prone to profligate spending, and also tried to correct some of the flaws in these rules. The landmark FRBM Act 2003, had committed the Union government to lowering its fiscal deficit to 3% of GDP and extinguishing its revenue deficit by 2009.
The Centre was on track to meet these targets thanks to record tax collections during the economic boom, but the downturn that began at the end of 2008 hurt revenue and forced the government to let its deficits soar to protect the Indian economy from global shocks. While reiterating the need to stick to tight deficit targets, TFC has also suggested that some flexibility be built into new fiscal rules so that the government can deal with “exogenous shocks” such as a global recession, a spike in oil prices or a drought, without being tied down by strict annual targets.
Such a requirement necessitates deep changes in the very nature of budget making in India. TFC hints that the finance ministry should move from an annual statement of revenue and spending to a rolling medium-term fiscal framework, of which the annual budget is but one part.
Any unexpected deviations from the promised medium-term path because of exceptional economic circumstances should be explained with the backing of clear evidence. It also says the medium-term fiscal plan should be “more a statement of commitment rather than merely on intent”.
Malik of Macquarie Securities poses a paradox to illustrate how political will is necessary if India is to lower its high levels of fiscal deficit and public debt. “If the government is disciplined, it does not require legislation (on fiscal targets). And if a government is not disciplined, it will find loopholes in the legislation.”
These targets are not to be achieved by cutting capital expenditure as govts have done in times of fiscal stress
Graphic by Ahmed Raza Khan / Mint
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First Published: Thu, Feb 25 2010. 10 17 PM IST