Choosing between hard and easy paths

Written by Ranen Banerjee | Updated: Feb 27 2013, 13:16pm hrs
The most significant reform initiative taken by the government of India in public financial management is the Fiscal Responsibility Budget Management (FRBM) Act. The Act mandated that the government achieve 3% fiscal deficit and revenue balance by 2008-09. As shown in the graph above, fiscal indicators did improve during 2004-08, with the fiscal deficit averaging 3.6%. The global economic meltdown had impacted the Indian economy and there was a sharp increase in the fiscal deficit from 2.5% during 2007-08 to 6% in 2008-09. The revenue deficit has moved from 1.05% in 2007-08 to 5.25% in 2009-10 and the primary balance turned deficit in 2008-09 after running in surplus in the previous years. The fiscal slippage has primarily been driven by the low economic activity starting with 2008-09, which had derailed the fiscal consolidation process that started post the enactment of the FRBM Act.

Weak economic activity led to a tax-GDP ratio lower than pre-crisis levels. Non-tax revenues faced a steep decline in 2008-09. To restrict the spiralling effect of demand contraction, the government introduced a plethora of fiscal incentives, which further added pressure on the exchequer. The government introduced three successive fiscal stimulus packages by cutting the excise duties and service tax, direct assistance to export industries, refund of excise duties/central sales tax. Other interventions such as increased spending on the Mahatma Gandhi National Rural Employment Guarantee Scheme, higher liabilities on account of the implementation of the Sixth Pay Commission recommendations on government employees salaries and pensions of retired employees, fertiliser and oil subsidies, Agriculture Debt Waiver and Debt Relief Scheme for farmers further aggravated the fiscal woes.

The issue was that the fiscal stimulus was directed towards revenue expenditure rather than adding major capital assets. Capital expenditure's share in total expenditure, after reaching as high as 15% in 2007-08, had fallen to 9-10% in the crisis period (also the period of fiscal stimulus). In 2008-09, revenue expenditure saw a growth of 34% while capital expenditure declined by 27%. The developmental revenue expenditure increased by 47% and developmental capital expenditure declined by 53% the same year. This highlights the turbulence through which the central government has traversed and the path of fiscal derailment.

The fiscal deficit, after reaching as high as 6.5% of GDP in 2009-10, came down to 4.9% in 2010-11. However, it again shot up to 5.9% in 2011-12 owing to a deceleration in economic activity, which negatively impacted tax collections. Revenue receipts as a proportion of GDP fell from an average of 10% in the preceding 5 years to 8.5% in 2011-12. This is despite a plethora of measures to enhance tax revenue, such as increasing the central excise rate from 4% to 5%, making ready-made garments subject to excise duty of 10%, etc. Revenue expenditure continued to grow, albeit with a mild moderation. Nonetheless, capital expenditure has witnessed stagnancy in 2011-12. It grew by a meagre 0.1%, reflecting the burden of fiscal adjustment on the economic catalyst sectors.

The path of fiscal consolidation remained quite bumpy in the past two years. In 2011-12, the efforts to contain the deficits were targeted towards increasing revenue collections by increasing the tax rates and by bringing additional services under the fold of the service tax net.

In 2012-13, the fiscal consolidation measures are based on receipts that are temporary in nature, such as disinvestment proceeds and auction of spectrum. On the expenditure side, there is a deceleration in plan expenditure. As of December 2012, plan expenditure in many critical departments remained low as against budgetary estimates. This was 18% in case of the ministry of power, 54% in the case of the rural development ministry, 53% in the department of school education and literacy, and 54% in the department of health and family welfare. It is difficult to spend more than 33% of budgetary estimates in some cases in the next three months (last quarter of FY13). However, the attempt to curtail non-plan expenditure is yet to be realised fully. Major departments such the ministry of rural development (73%), health and family welfare (94%), and school education and literacy (73%) have spent more than 70% of their budgeted non-plan expenditure in the first three quarters of the financial year.

Therefore, the axe of fiscal consolidation has been on plan or developmental expenditure that leads to expansion of real economic activity feeding into long-term revenues for the government. A volatile revenue source with curtailment of capital expenditure is not an appropriate route to achieve fiscal consolidation. It remains to be seen if the finance minster will continue on the easier path of fiscal consolidation by limiting capital expenditure as in the past, or a hard path of real fiscal consolidation by pruning non-plan expenditure.

The author is executive director, public sector & governance, PwC India