Much Ado about Nothing Much, Except the Fate of Fiscal Consolidation

Trucks on a Rorotrain at Khed in Maharashtra. Credit: Arne Huckelheim Wikipedia commons

Trucks on a Rorotrain at Khed in Maharashtra. Credit: Arne Huckelheim Wikipedia commons

A struggle is going on in government policy circles over whether the fiscal consolidation roadmap presented in last year’s Union Budget should be adhered to in the interest of probity and responsible conduct or whether it should be set aside in the interest of economic growth. The argument has reportedly been presented to Prime Minister Narendra Modi, no less, for adjudication. The facts, however, are mundane and unfortunately depressing.

The Medium Term Fiscal Policy Statement (MTFP), part of the Fiscal Responsibility and Budget Management Act (FRBM), 2003, originally envisaged the shrinking of the revenue deficit to zero and the fiscal deficit to 3% of GDP in five years (by 2008), with some of the tough provisions of the original bill watered down for digestive ease. The global financial crisis of 2007-08 interrupted this timeline, although burgeoning petroleum subsidies and its accounting treatment had already eroded things a bit. India could have begun to mend the fiscal stance around late 2009, but did not; instead the extended waiver continued until 2012. A five year holiday, so to say.

In September 2012, a committee headed by noted economist Vijay Kelkar made recommendations on fiscal consolidation, which were incorporated in the MTFP of Budget 2013-14. Bowing to political realities, the committee introduced the concept of “rolling targets”, made out for only two years at a time, and projected that in 2014-15, the revenue deficit should be 2 % and the fiscal deficit 3.9% of GDP. In 2016, we are not yet there. Indeed, the Budget for 2015-16 had argued for leniency and set the revenue deficit target at 2.8 % and the fiscal deficit at 3.9% of GDP.

Let us look at it this way: in 2003, we had set out in parliament a solemn path to get somewhere by 2008. In 2016, we are still quite a way from that target, and are now arguing about pushing the terminal date back from 2017-18 by a year or two.

Critics of the move have invoked the moral high ground of responsibility and prudence. It is always easier to criticise the other person, while doing nothing on your own watch. That aside, who in their right mind would not take the proposed deferment as but one more instance of India’s affinity for procrastination and aversion to discipline? Nobody who invests money, that’s who. In market parlance, one could say that the reluctance of Indians to exercise discipline and the inclination to push tough decisions to a later date is built into the price of Indian assets.

To understand the government’s position on fiscal consolidation, it is important to ask three questions:

Do they matter at all?

There are advocates of the dirigisme regime pre-1991 who simply love the failed medicine of fiscal stimulus – it was an addiction, but not to fiscal indiscipline per se. It is to the asphyxiating state control that births the perennially expansive fiscal stance and its twin, financial repression. Indian communists seem to see great virtue in fiscal deficits, the larger the better. This is rather surprising as their fraternal party, the Communist Party of China, maintained a conservative fiscal stance in its four-decade rush to become the world’s second biggest economy. That aside, large fiscal deficits deny resources to the private sector (“crowding out”), misuse domestic savings, create multiple instabilities and condemns the economy to the perennial life of a basket case shunned by all. Thus, parliament’s decision to endorse responsible management of government finances was an important milestone, even if in implementing it we show our native penchant for indiscipline. Where else do people think it alright to just turn on their headlights and drive down the wrong side of the road?

MTFP and “rolling targets”

Given the repeated passes sought and deferments made in the second coming of the MTFP, is it any longer meaningful to have a MTFP and targets, however “rolling”? Actually, it does. A target is the only hard constraint in the budget. Most of everything else (other than interest, salaries and pensions) is flexible and fungible – more of one, less of the other, but if and only if there is a hard budget constraint, such as a pre-determined fiscal deficit. Otherwise from the sheer goodness of heart would spring the desire – more of this, more of that, more of everything!

The tighter the constraint, the more we have to search to squeeze out the unproductive and protect the productive. This must be done despite the inbuilt inertia in the system that tends to push resources towards the unproductive. Take the Indian Railways, for instance, a fine organisation of which we are proud. It moves 23 million people and 3 million tonnes of freight on 19,000 trains every day. But India needs more trains, and that needs more funding for investment.

The operating ratio (cost percent revenue) of the Indian Railways used to be 83% in the early 1990s but has since risen to low- to mid-90%, barring 2005-06 (84%), 2006-07 (79%) and 2007-08 (76%), when Lalu Prasad Yadav led the ministry.

The principal bane of the Railways’ financial operations is the pricing of its services. It hugely subsidises passenger fare (coaching) while inordinately taxing freight; the cost coverage for coaching services used to be 62.0% in 1999-2000, but fell to 49.4% in 2012-13, while that for freight was 129.3% in 1999-2000 and rose to 163.7% in 2012-13. These ratios likely worsened in 2013-14 and 2014-15, as well as in 2015-16 when Suresh Prabhu chose to increase freight rates in his last Budget. Were the cost coverage for coaching revert to the 1999-2000 level, this would allow freight to be taxed less, and generate adequate internal funds for the Railways’ to investment.

In 2011, India’s fare per passenger kilometre was 0.6 US cents, while in China it was four times higher, at 2.4 cents. In Germany, the fare per passenger kilometre was 12.6 cents, 21 times higher than that in India. For freight, it was the opposite. The yield per tonne kilometre in India was 2.11 cents, 40% more than China at 1.49 cents, and almost the same as the 2.28 cents in the US. In other words, when it comes to freight, the Indian Railways charges the same rates as the US, while diverting the surplus to subsidise coaching to one quarter the rate of that in China. The consequences of this have been major; it has pushed private goods for long haulage to road – a bad outcome for both safety and the environment.

Will a hard budget constraint make reform happen? It may or may not, an answer entirely dependent on the government in power.

Does the government have a choice?

The sobering answer is, not really. This is mainly due to five reasons:

No action on fertiliser and other subsidies has meant that these expenditures have not yielded any space – which they should have, considering the massive decline in oil and import prices for fertiliser. Food is a touchy area, but in dire need of reform. We know from National Sample Survey Organisation data that at least 40% of foodgrain that moves through the public distribution system (PDS) is stolen and ends up in the market; that is, 50,000-crore rupees worth foodgrain is stolen each year.

Indeed, 5.75 million people voluntarily gave up LPG subsidy (including this author), but that is only 3.5% of all consumers. In 2012, subsidy was limited up to six cylinders per year, which is what poor households consume. Two-thirds or more of PDS kerosene is diverted. If poor people get kerosene, they mostly do so at market prices. Perhaps the government should consider transferring the subsidy value of six cylinders or as many litres of kerosene to below poverty line households and let LPG and kerosene be freely priced and easily available, but this has not been done so far. As a result, the subsidy burden will be higher in 2016-17 than this year.

Although the tax collections target in 2015-16 will be exceeded due to the one-time benefit of about 80,000 crore rupees from higher taxes on automotive fuels, this will not happen again next year. The statistics department says the Indian economy is growing at 7.6%, but the experience on ground proves otherwise. The nominal value of company sales (excluding energy, metals and mining) is rising 4% to 5% year on year. Employment and livelihood growth has slowed. Where is the growth in the taxable base for tax collections to grow strongly in 2016-17?

Disinvestment proceeds are likely to fall short by 80% in 2015-16 and this may happen in the next year too. The atmosphere of suspicion created over the past few years weighs on officers and works to the detriment of disinvestment. Is it not likely that an auditor or investigator will, with the advantage of hindsight, criticise the decision and claim that large losses were caused to the treasury?

The Seventh Pay Commission has hiked salaries and the first-year impact on the Centre and Railways is over one lakh crore rupees. A legitimate motive of increasing the salaries of government servants was to maintain some kind of parity with the private sector, at least for educated personnel. In the past six to eight years, private sector salaries at all levels have grown sluggishly and the prospects remain poor for the coming year. Yet the Commission proposed a 10–11% annual pay increase for all government employees for the next ten years, on top of a similar increase in the past ten.

The statistics department has lowered the estimate of GDP at current prices. This hits 2015-16 and 2016-17 targets by 0.4 percentage points. It ought not to matter much as representing targets as a percentage of GDP is customary. What is important is the rupee estimate. But it makes life even harder for the mandarins in North Block.

These are the issues that impede the deferment of the “rolling targets”, which will roll a bit more. It is not about moral high or low grounds, nor about boosting growth, but just the inevitable consequence of the lack of reform, weak economic growth, frittered away benefit of low oil prices, compulsive pay hikes and some bad luck with the statistics department.

(Saumitra Chaudhuri was formerly a member of the Planning Commission and the Economic Advisory Council to the Prime Minister)