The Fiscal Opaqueness Bill

Updated: Nov 3 2003, 05:30am hrs
The Fiscal Responsibility Bill (FRB) was passed this summer by Parliament. This is a watered-down version of the original Fiscal Responsibility and Budget Management Bill (FRBMB) that was brought before Parliament in December 2000. While the original Bill also had explicit fiscal deficit and debt targets, the FRB has only a zero revenue deficit target. But it would be fair to say that the critical essence of the original Bill has been preserved.

This article points out the problems with this zero revenue deficit target and is a critique of both Bills. The revenue deficit is the sum of the primary revenue deficit and interest payments (see Table). Interest payments on the Consolidated Fund of India, which comprises the bulk of debt, are committed under the Constitution. Default on the remaining debt is not under consideration. Therefore, int-erest payments are given from the standpoint of annual budgetary decisions. Hence, cutting the revenue deficit means cutting the primary revenue deficit, either by raising more taxes or by reducing primary revenue spending.

In critiquing the original FRBMB, I wrote The fundamental and overwhelming rationale for a primary deficit target is that it is wholly and solely under the finance ministers control (ET, March 22, 2001). Total deficit targets make it difficult to hold the fiscal authority responsible for achieving its target. The only way to achieve a zero revenue deficit target is to perpetually run a primary revenue surplus to offset the interest payments. For fiscal 2002-03, a zero revenue deficit target would thus entail a primary revenue surplus of 4.5% of GDP. It is not desirable or feasible to raise taxes or cut spending so much over the five-year time horizon set to achieve the target. The choice of a primary deficit versus primary revenue deficit target is a separate, second level issue requiring judgement as to how productive are government capital expenditures. If they add significantly to growth, and ultimately to tax or non-tax revenues, then substantial borrowing to fin-ance capital expenditures should be allowed. But if they do not deliver as expected, then a stringent curb on the primary deficit makes sense.

It is unfortunate that revenue deficit targets are so deeply entrenched in the current policy framework.They are distorting the incentives for good fiscal management by finance departments (Centre or state). Unexpected drops in world interest rates have been easing Indias interest payments burden over the last three years.

Market interest rates have fallen sharply in India since 2001 due to the US economic situation and the associated reduction of the US federal funds rate. Our financial markets are now so closely linked to the world that the favourable impact of the US situation is manifesting itself in lowered cost of debt of new issues and more so through debt swaps for states and debt buybacks by the Centre. The ensuing revenue deficit reduction can be mistaken for good fiscal management. More spe-cifically, improvements in the revenue deficits of the states are now getting rewarded as per 11th Finance Commission criteria for transfer of funds to states. A Rs 10,000 crore incentive fund was created to reward states that achieve a 5 percentage point reduction in their revenue deficit to revenue receipts ratio in each year until 2004-05.

By contrast, a primary (revenue) deficit target will not reward states for their good luck, nor penalise them if the cost of borrowing suddenly rises and pushes up the revenue deficit. A separate scheme can always be devised to reward states that reduce interest payments by debt swaps and debt buybacks.

Sound fiscal policy should start with conceptual clarity about the fundamental economic differences in the components of the revenue deficit.

The writer is visiting professor, Centre for Economic and Social Policy, JNU. He can be contacted at