Two holy cows are prominent in Indian debates about government expenditure. Capital expenditure by the government is considered desirable, even essential to high GDP growth. Therefore, Plan expenditure is somehow good. Non-Plan expenditure is bad, since it is not ?development oriented? and thus unworthy. The reality is that neither of these propositions stands up to scrutiny. This has important implications for the evolution of the country?s approach to fiscal responsibility and budget management (FRBM).
Let?s start with capital expenditure. The biggest figure for the Centre?s capital expenditure was 7.8%, seen in 1986-87. The public sector?s footprint at the time was enormous. Of the country?s total gross capital formation figure of 25.6% of GDP, as much as 13.1% of GDP (another all-time high) was done by the public sector. In other words, in 1986-87, more than half of all investment in India was controlled by the government and its various arms.
From these heights, the role of the public sector has declined sharply. In 2006-07, overall gross capital formation had risen to an astonishing 39.4% of GDP. Of this, just 8.5% was done by the public sector, and only about 2% of GDP was central government capital expenditure.
In terms of results, in 1986-87, India was clocking roughly 5% trend growth, and was on the verge of a currency crisis. By 2006-07, India had moved up to 8% trend growth, with no crisis in sight. This was a year of high GDP growth despite very low public sector investment. Compare this with 1986-87, a year of low GDP growth despite very high public sector investment. This demonstrates that high public investment is neither necessary nor sufficient for high GDP growth.
Given the inefficiency of public sector investment, and contrasted with the care with which the private sector husbands its resources, it is not surprising that a high public investment strategy did not work. India?s GDP acceleration over the last 20 years was assisted by the fact that government reduced its participation in the economy, going from over half of total capital formation to one-fourth. We may well obtain a further acceleration in growth by further driving down public sector investment to below 5% of GDP, thus freeing up greater resources to be allocated and managed by the private sector?which obtains a better bang for the buck than does public investment.
How can this perspective be reconciled with India?s need for transportation and communications infrastructure? Massive investments in roads, telecom, ports, airports etcetera can and should take place, but it is quite feasible to place these on the balance sheet of the private sector. There is an integral role for government in regulation and contract issuance for complex PPP projects. There may be a role for government in providing small sums of ?viability gap funding? (which would be current and not capital expenditure) to whet the private sector?s appetite for long-gestation infrastructure investments with uncertain payoffs. Once contracts are signed, the actual investment is better undertaken by private parties, who are more careful with money.
This brings us back to the debate on FRBM limits on the fiscal deficit versus limits on the revenue deficit. At present, it is felt that while revenue deficits are bad, it is okay for the government to run up deficits as long as the money is being used for capital expenditure. Central capital expenditure is now down to 2% of GDP, and half of this is defence hardware. It would be sensible now to abandon the distinction between the revenue and fiscal deficit in the FRBM scorecard, and instead simply insist that the government must live within its means. In other words, FRBM rules should insist on a fiscal deficit of no worse than zero, except in case of an occasional calamity.
The second holy cow that merits examination is the beneficial or ?developmental? nature of Plan expenditure as opposed to the unhealthy overheads recorded as non-plan expenditure. Plan expenditure comprises expenditure on schemes that are processed through the Planning Commission.
Is Plan expenditure always a good thing? There is no evidence that money spent through the Planning Commission delivers more bang for the buck. The Commission has been complicit over several decades in massive government programmes that have led to theft, wastage, corruption and recruitment of party workers as civil servants. In 1986-87, Plan expenditure was at an all-time high of 8.1% of GDP. This was slashed to 4.1% of GDP by 1998-99, which helped set the stage for the ignition of high GDP growth in recent years. There is no reason to cherish Plan expenditure.
The most fundamental role of a State lies in internal and external security. External security involves defence expenditure, which is non-Plan. Internal security involves the police and judiciary, which are non-plan as well. Safety and law-and-order are the core tasks of the State. The Indian State has been floundering on these. The number one priority of the government should be to strengthen the police and the judiciary. This requires more non-plan expenditure. If getting to this requires reducing Plan expenditure to below 3% of GDP, we should be quite comfortable with this.
Ila Patnaik is senior fellow at National Institute of Public Finance and Policy. These are her personal views