Budget: Should we have a fiscal policy committee?

By: | Published: October 3, 2016 6:22 AM

Economics and the stock-markets have one commonality—based on the same data, different practitioners can come up with theoretically-sound analysis and conclusions that are at divergence.

The formation of the MPC is evidently a major milestone in the way in which policy is conducted. (Source: Reuters)The formation of the MPC is evidently a major milestone in the way in which policy is conducted. (Source: Reuters)

Economics and the stock-markets have one commonality—based on the same data, different practitioners can come up with theoretically-sound analysis and conclusions that are at divergence. Look at technical analysis where experts draw their inferences from a common data-set and make recommendations. The same is the case with economists. There are sound models which show that Indian exports can gain from devaluation and there are others which say that the exchange rate does not really matter and global growth is relevant. Based on this observation, it would be interesting to see how the three academicians on the Monetary Policy Committee (MPC) agree or disagree, as they would have strong views supported by sound theory and models.

The formation of the MPC is evidently a major milestone in the way in which policy is conducted. There is however the possibility that if the three RBI members think alike, or strategically get into a game where they “collude”, and their view prevails, given, even if there is a tie, the RBI Governor will have the casting vote.

But the more interesting extrapolation that logically follows is that if monetary policy action should be a consensus-driven decision, then the same rule could also apply to fiscal policy. In fact, it was largely expected that the MPC would have a mix of representatives of various interest-groups, and include a corporate-representative, a representative of the households (as it affects savings) apart from an academician. As the government decision was to appoint three academicians, it is but natural that a similar rule may be applied for the Fiscal Policy Committee (FPC). Let us see how this can work.

Having a six-member committee would be conceptually similar to the MPC. Again, three members can be from the government while three can be from outside. The internal members could be the FM, complemented by two others from the finance ministry—maybe perhaps the finance secretary and the secretary of the department of economic affairs. The other three members would be experts from outside and could include one member representing the corporate sector, another representing the common-man and the third an academician. Having someone from RBI in place of the academician would also add value and, in a way, address the concerns of the central bank, especially when it comes to market borrowings.

Just like how the MPC has a written agreement between RBI and the ministry of finance, the FPC could have an agreement which is based on the FRBM (maybe the one that is to crystallise soon). The basic contours will be delineated in the form of target deficit-ratios and debt parameters that have to be adhered to. The exact glide-path would be the prerogative of the FPC. At present, there is a growing view that sticking to a fiscal deficit number of 3% is not prudent and there should be some flexibility offered to the government. The same can be decided by the FPC.

Important issues that will receive attention in this dispensation would be the direct tax rates and their movements while the GST would fix the indirect tax rates. The amount of subsidy and the delivery of the same would also be decided by the FPC. Similarly, the amount to be spent on capital would be its domain. Monitoring incentives in terms of depreciation allowance, investment allowance, tax holidays, etc, can be other areas which would also be a part of the FPC’s responsibility.

As is the case with the MPC, the FM would have the prerogative to veto in case of a tie, or have his view prevail. The difference from the present regime will be that the Budget will be a consultative process not just between departments of the government and the states, but would also get in the views of other practitioners, so that there is a semblance of cohesion in thinking. At present, there are several representations made by industry groups to the government which are considered as are other demands made by associations representing the interests of tax-payers or a particular profession. The challenge for any government is how one balances out these numbers given that every demand is invariably in the direction of paying less tax which makes it difficult to balance the budget or results in constraints on expenditure.

With FPC members jointly discussing these views, the final decision could steer towards the flexible FRBM ratios that can be pursued. The advantage is that the budget does not move unilaterally, in a single direction, and there is scope for moving along a corridor set up by the committee rather than by the ministry. This will add credibility to the process too and probably make it more objective.

In case this model works well, it can be replicated to the state budgets, too. An argument against such an approach can be that the government loses its autonomy in budget formulation. For example, a government may promise certain household items to the electorate and would have to meet this commitment, which may not go down well with the FPC. Here, as mentioned earlier, the FM will still have the clinching vote but having a consensus on proposals will impose some checks on the process.

One of the two questions that remain to be answered is: What would happen in case the targets are not met? In case of the MPC, RBI is answerable—by the same principle, the ministry of finance would have to provide an explanation. Here, it could be made answerable to the Parliament, though the downside is that the process can be vitiated by ‘political noise’. Alternatively, it can be made answerable to the prime minister directly, which appears feasible and is workable. The second question is: The MPC is to meet 4 times a year; what should be the ideal frequency for the FPC in meeting? Ideally, a quarterly meeting would be called for where in extreme cases there can be a change in targets and variables in case it is so warranted. This way there is constant monitoring of the budget which will also bring about better management.

Having a FPC is worth considering the budget is the most critical economic exercise that is carried out in any country. While it has hitherto been the government’s prerogative to make allocations and change tax rates, getting the expert opinion will bring in some moderation and also less criticism, which has become a habit these days. If successful, this can be a useful template for other countries too which are always paying obeisance to an ideology of fiscal prudence which though advisable cannot be cast in stone.

The author is chief economist,

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