Some hard-headed counselling on fiscal policy

By S. Swaminathan

The Annual Report of the Reserve Bank of India (1999-2000) released earlier this week maintains the pristine tradition of the central bank surveying a wide range of macro-economic developments extending far beyond the radar-screen of the monetary authorities. Chapter VII of the Report ``Assessment and Prospects'' covers not merely the major contours of the Indian economy for the year under review but offers a retrospective on macro-economic developments since the 1991 crisis.

The section on ``Fiscal Imbalance'' is particularly noteworthy for the insights and the perspective which the RBI offers to the government at the Centre and in the States on how fiscal policy can be redeemed from its accumulated maladjustments. That the RBI speaks candidly on the subject is not to be viewed as some unprecedented streak of conscious autonomy on its part but rather as a continuing tradition. To the extent that many challenges encountered by the RBI in the sphere of monetary management stem from a chronic state of fiscal disorder, the counsel offered by the RBI cannot all be regarded as ``disinterested advice.''

Action for fiscal turnaround

Noting that the combined gross fiscal deficit of the Centre and the States in 1999-2000 had exceeded the projections by 2.5 percentage points of the GDP at 9.9 per cent, the RBI expresses concern that ``any further erosion of the fiscal position could turn out to be unsustainable''. Whoever could describe this as a far-fetched fear even if on the question of fiscal prudence there is ``no one best way''? But as the RBI puts it, ``The need for a turnaround in the fiscal position is well recognised, but it requires a multi-pronged effort at improving revenue buoyancy, in particular tax collections, effecting necessary expenditure reductions and raising proceeds from divestment of selected public enterprises.''

Unlike some fiscal policy analysts who would look at the problem of fiscal correction largely in terms of maximising the tax effort, the RBI holds the view that Expenditure Management is ``the key to achieving overall fiscal prudence.'' It minces no words about ``the large size of the Government'' and the need for pruning it. The combined government sector expenditure as a percentage of the GDP at 28.7 per cent in 1999-2000 as compared to 30.6 per cent in 1990-91, continues to remain high.

Excepting for defence expenditure and statutory grants to States which are ``exogenously given'', the RBI would urge for ``strong policy actions.'' The interest burden on the Central budget ``could over time be reduced by containing fiscal deficits'' but whether the problem can at all be mitigated without the retirement of a substantial component of public debt does not appear to have received appropriate emphasis by the RBI.

Nevertheless, the RBI includes ``plugging leakages and misappropriations'' as part of ``strong policy actions'' even if there is some ambiguity about the specific context. On the protracted debate on subsidies, the RBI seems to be adding a mere semantic contribution by saying that subsidies could be oriented to operate as ``social safety nets.''

The fact that between 1991-92 and 1999-2000, the expenditure of the Central Government on wages and salaries has grown at an annual average rate of 14.8 per cent (compared to 12.5 per cent growth in overall expenditure) drives the RBI to the conclusion that ``unless the size of the Government is pruned, the wage bill would pose a significant burden on fiscal management.'' That the situation is indeed serious is made out by the RBI when it says that ``there is an urgent need to ensure that solvency of public finances in respect of pensions and other unfunded liabilities is attained.''

Tax-GDP ratio

Over a long period, 1985-86 to 1999-2000, there has been a slowdown in revenue collections as indicated by a deterioration in the tax-GDP ratio of the Centre and States together, from 16.4 per cent to 14.1 per cent. The imperative is clear that the tax ratio must move up along with the pace of growth of the economy, consistent with experience in other developing countries.

The RBI makes the important point that ``the structural shift in the composition of GDP seems to have constrained growth in tax receipts.'' Two factors are relevant here. The first is the anomaly of the agriculture sector remaining out of the tax net. The second is that the tax system is yet to take adequate cognisance of the fast-growing ``services sector.'' What is equally important, as the RBI emphasises, ``The wide-ranging tax exemptions and concessions extended to various sectors of the economy need to be rationalised after a thorough examination of the effectiveness of such concessions in promoting intended aims or in augmenting the growth of the particular sectors for which they have been extended.'' There is no question that this is long overdue. Nor is the RBI exaggerating the need for streamlining stamp duties and registration fees, at the State level, which have tended to reduce revenue collections by dampening the volume of transactions.

PSE disinvestment

The RBI has drawn attention to the dismal record in disinvestment (at the Centre) and to the failure to increase user charges and to provide greater managerial autonomy in PSEs (at the State level). So far as the Centre is concerned, the RBI seems to prefer a system of multiple options in the matter of PSE disinvestment. Ensuring a semblance of the expected fiscal outcome would call for ``different scenarios'' being drawn up corresponding to differing capital market conditions and investor preferences. Good advice but such as would not make a difference to a Government caught in a deep maze of contradictory positions on disinvestment!

The RBI is all for a strong institutional mechanism for ensuring fiscal responsibility at the Centre and in the States. A Fiscal Responsibility Legislation is necessary but for it to be credible ``it should include stringent requirements for fiscal transparency, backed by strong enforcement mechanisms.'' Is Mr. Sinha tuned to the RBI waveband?

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