Parliamentary oversight does sometimes work

By Prem Shankar Jha

Eleven months ago, the Vajpayee Government introduced a Fiscal Responsibility Bill in Parliament to bind itself and all future governments to bringing the Central Government's fiscal deficit down to 2 per cent of GDP by 2005-06 from 5.5 per cent last year. The Bill did not get passed immediately but got referred to the Standing Committee on Finance. The committee has now come back with a bunch of suggestions that, if accepted, will pull every one of its teeth. The most important recommendation is that the amounts by which the deficit should be reduced and the ceiling on deficit financing should not be assigned numbers in the act itself, but befixed annually by the Government under the rules for implementation of the Act.

The committee's second suggestion is that there should be no blanket ban on borrowing by the Government from the Reserve Bank of India. As borrowing from the central bank is an euphemism for deficit financing, if passed in its original form the Act would prohibit deficit financing by law. Future governments will then have to cover it deficits by borrowing from the market at commercial rates, and that will serve as a healthy deterrent to excess spending.

On the face of it, this is the last nail in the coffin of Mr. Yashwant Sinha's attempt to bring down the fiscal deficit to a manageable level, and restart sustainable economic growth. In the budget for 2001-02, he had promised a second generation of economic reforms that would include decontrol of petroleum product prices within two years, decontrol of fertilizer prices within five years, an immediate end to unlimited food procurement, and an amendment to the Industrial Disputes Act that would permit enterprises employing less than 1,000 workers to lay off without getting the prior permission of the Government. Had the first three been implemented, they would have halved the fiscal deficit to about Rs. 60,000 crores over the next four years. But not a single one of these reforms has gone through.

Mr. Sinha had expressed the hope that the passage of the Fiscal Responsibility Act would put just enough additional pressure on the ministries concerned to implement these and other cost cutting decisions. But by making every fiscal constraint negotiable, the standing committee has made it subject to executive discretion and parliamentary oversight, all over again. Thus, the entire edifice of Mr. Sinha's fiscal reform now lies in ruins.

The standing committee's action thus looks retrograde. Ever since the era of economic reforms began, governments in every country, making the transition from a command to a market economy, have been hunting for ways to shield the sharp changes of economic policy that this requires from the vagaries of politics. 'Shock therapy' - doing all reform in one brutal stroke so as to stun the opponents into submission, at least for long enough to let the reforms start yielding fruit - was one product of this search. The Currency Board, pioneered by Hong Kong and adopted by Argentina, in which the exchange rate and full convertibility are mandated by an Act of Parliament, and the government is forced to tailor all other policies accordingly, is another. Fiscal responsibility was a third such innovation.

But a closer look shows that for once the standing committee is in the right and the advocates of de-politicising economic reform are wrong. Shock therapy has caused economic dislocation and social backlashes in every country that has tried it. By the same token, the Currency Board experiment has caused record unemployment and economic stagnation in Argentina and brought the economy to the verge of collapse.

The Fiscal Responsibility Bill was another milder attempt to put hard economic decisions outside the reach of politics. But it too was based on the same faulty premise as shock therapy and the Currency board, namely that it is possible to separate economics from politics. The standing committee has rightly rubbished the idea what is needed for fiscal reform is not an act of parliament, but political will backed by an informed awareness of the consequences of not setting the country's finances right. If the awareness and political will exist, there is no need for a Fiscal Responsibility Act. If they do not, then such an Act will be circumvented by one means or another.

Mr. Sinha's own failure to implement the financial reforms he had promised illustrates this point admirably. Had oil prices stayed at$30 a barrel, the price that had prevailed at the beginning of this year, the total subsidy that the Government would have had to pay out would have amounted to over Rs. 30,000 crores. Decontrolling oil prices would, therefore, have sent the prices of some products shooting up, notably kerosene, cooking gas, and diesel for transport. Mr. Sinha, therefore, gave the Government two years to complete the job, starting in April 2000.

But was there any need to wait the full two years? By August, under the spur of recession, oil prices had fallen to around $20 for India and since then have fallen below $18. At these prices there is no subsidy left. As a result decontrol has no price tag. All that the government would have to do is to lower some prices while it raises others to end the cross-subsidies that have plagued this sector while it has been under the Government control. As gasoline prices would have almost certainly gone down and would have compensated to a large extent for the rise in cooking gas prices, this would have won the NDA some much needed friends. So what prevents the Government from announcing oil prices decontrol straightway? How does it know that oil prices will not rise by February and make the initial price decontrol more politically difficult?

By the same token, when four-fifths of the subsidies on fertlizers goes not to the farmer but to high cost domestic manufacturers who have gold plated their capital costs to increase their profits under the retention price system of price fixation, why is the Government intent upon keeping this system going for another five years?

On the other hand, Mr. Sinha's announcement last February that in future the central government would only procure enough foodgrains to maintain a buffer stock of 18 to 24 million tonnes, was ignored because it did not give the state governments and the wheat and rice farmers of Punjab, Haryana, Western U.P. and Andhra Pradesh any time to shift out of foodgrains or to build up the marketing, cold storage and other infrastructure that is needed to make the shift profitable. If there is any area in which the Government needs to announce a five year phase-out programme it is this.

The three examples cited above show why fixed schedules of deficit reduction are likely to prove counter-productive. The reason is that they can inhibit reduction where it can be done faster and force the pace of reduction where this can do harm. But this is only half the story. Had it been passed in its original form, the Fiscal Responsibility Act would have in effect devolved the task of cutting expenditure and increasing revenue upon individual ministries. Each would have had to be given a target, and each minister would have asked why he was being asked to impose hardships on the people while his colleagues were getting off scot-free.

Each would have tried to pass the buck, and this would have become another potent cause of discord in this and future coalition governments. This would have been especially disruptive when the ministries asked to make the maximum cuts in subsidies or other expenditures were given to minor partners in the ruling alliance with strong bases in only a single state.

The truth is that the potential for cost cutting is not evenly distributed across ministries. The decision on where the axe must fall has necessarily to be centralised in the hands of the Prime Minister and his Finance Minister. Only the former has the holistic view needed to ensure that the cuts are made in such a way as to impose the minimum of social cost on the people and political cost on the government.

There are equally strong reasons for not banning deficit financing by law. The most important is that, as China has shown and India has not dared to emulate, deficit financing can be used to counteract a strong recession without causing inflation. Chin has been spending $12 to 18 billion of Treasury financed borrowings to boost expenditure on infrastructure since 1998. Not only has it transformed the country, but it has successfully fended off an economic collapse that seemed around the corner in September 1998. The Indian government must at least retain the right to do similar things if the need arose. In fact, that is precisely what it should be doing today.

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