Montek vs Chidambaram : The Middle Path

Updated: Aug 31 2006, 05:30am hrs
Historical Fact 1: No sooner than he took over the reins at North Block in June 2004, P Chidambaram expedited the notifi-cation of the rules under the Fiscal Responsibility and Budget Management Act. The move was intended to clear any doubts at international fora about the reform credentials and intentions of a coalition government, particularly one with Left support.

Historical Fact 2: The same Chidam-baram hit the pause button eight months later. The Budget for 2005-06 estimated a fiscal deficit of 4.3% of gross domestic product, which is 0.3% higher than 4% in 2004-05. The FRBM rules clearly specify a 0.3% cut in fiscal deficit every year till it reaches 3% of GDP.

The finance minister may have had good reasons to pause for a year. But today, he feels otherwise. Such a move, he says, will hurt the governments credibility since it implies transferring responsibility to the future government after elections. And the Reserve Bank of India backed him by saying that a weak fiscal position will adversely impact the prospects of India getting investment grade rating from international agencies.

In his response to the Planning Commissions approach paper to the Eleventh Plan, Chidambaram ruled out any relaxation on the FRBM front, putting a question mark on how Monteks resource requirements for the Plan would be met. Montek needs money equivalent to 1% of GDP in 2007 alone for implementing the NCMP mandate. Not one to be provoked easily, his frustration sho-wed when he told a news agency, We really dont care for FRBM targets so long as we get the money. We are just bothered about the resources for the Eleventh Plan. This surprised many sin-ce Montek himself is a strong advocate of fiscal discipline.

States have started
holding surplus cash balances as evidenced from their investment
in Treasury Bills
Chidambaram, hopefully, will not join the issue. But, the issue has been flagged and when two stalwarts of Cabinet-rank fight, it is bound to attract PM Manmohan Singhs attention. Being the chairman of the Planning Commission and the PM, he will take a view in due course.

There is, however, a middle path or a compromise formula, so to speak, now being discussed in the corridors of power. What international credit rating agencies are bothered about is the combined fiscal deficit level of the Centre and states, and not just the Centre alone. Is it not possible that states relax the FRBM targets and the Centre sticks to itOr, the other way round If the combined fiscal deficit of the Centre and states is around 6% of the total GDP, then credibility of the country is maintained.

The option, prima facie, makes sense since states have improved their finances remarkably in the last two years. In a recent meeting of the parliamentary consultative committee of his ministry, Chidambaram pointed out that the fiscal deficit of states had dropped to 3.24% of the GSDP in 2005-06 compared with 3.47% the previous year. The revenue deficit too came down by Rs 19,615 crore to Rs 19,825 crore in 2005-06.

In fact, he went on to say that states may not be able to sustain the marked correction in fiscal indicators in 2005-06, unless the issues of revenue augmentation, rationalisation of expenditure reforms and containment of debt within the sustainable limit over the medium-term are addressed. The correction has to be gradual and steady. Any fiscal correction path under the fiscal responsibility legislation has to be realistic. The process of correction should not adversely impact the capital expenditure and spending on social services, he said.

States have, for the first time, started holding surplus cash balances as evidenced from their investment in Treasury Bills. They are holding over Rs 53,000 crore as surplus invested in T-Bills. Much of this is because of the large transfers from the Centre in the light of the Twelfth Finance Commission recommendations.

Given this scenario, it is possible that states are advised to relax their FRBM target while the Centre sticks to it. This way, there will not be a tightening of the belt for both the Centre and states, giving space for expenditure on social programmes fulfilling the NCMP mandate. For 2006-07, the total fiscal deficit of all states is projected at Rs 1,04,195 crore which is 2.67% of the GSDP. The combined fiscal deficit of states and the Centre (if both meet their Budget estimate) would then be 6.47% of the total GDP, the Centres deficit being budgeted at 3.8% of the GDP.