There’s a need to mitigate medium-term risks arising from Budget

There is general consensus, even in official circles, that India’s highly expansionary Budget for the 2010 fiscal carries significant medium-term risks for growth and price stability.

This column focuses on the reasons for the above consensus concerning medium-term risks, and suggests measures which could help in mitigating them.

First, projected fiscal deficits in FY 2009 (6.1% of GDP) and in FY 2010 (6.8% of GDP) are more than twice the targets set under the Fiscal Responsibility and Budget Management (FRBM) Act of 2003.

Moreover, the projected fiscal deficits are in the context of dangerously high internal public debt to GDP ratio of 66% in 2007-08. This ratio is expected to rise further as both the Centre and the States pursue short-term growth through government expenditure expansion financed by borrowing. The Budget has already relaxed the FRBM targets for the states to 4% of States’ GDP instead of 3.5%. The anticipated development of the municipal bond market, while meriting serious consideration, would also raise the total government debt further.

Second, the lack of urgency and focus on fiscal consolidation will severely constrain future fiscal flexibility in allocating expenditure in areas that will enhance growth and social cohesion, and meet India’s urgent external and internal security needs as a rising power. Thus, for the Central government alone, interest payments are projected to be 3.8% of GDP (about a quarter of its current expenditure) in FY 2010. If salary, pension and other statutory expenditures are added, very little will be left to meet changing priorities.

As an example, increasing life expectancy of an average Indian (an Indian reaching age 60 is expected to live another 20 years on the average, and this will rise in the future); and prevalence of lifestyle diseases will require much greater expenditure on healthcare for people at all levels of income. Much of this increase will need to be financed from public sources.

The mandatory New Pension Scheme (NPS) for civil servants introduced in 2004 has already had a positive impact on the expenditure discipline as the government must set aside pension liabilities each month instead of meeting such expenditure from current revenues. But the NPS will not be able to generate fiscal savings until much later as it covers only those who have joined the civil service after January 2004. Moreover, as the number of elderly increases, the budgetary expenditure on social assistance or pensions to the elderly will need to increase considerably.

The Budget could have given greater impetus to the voluntary NPS available to all Indian citizens from May 1, 2009 by rationalising the tax treatment to provide a level playing field with other retirement products such as the mandatory provident funds.

It is encouraging that the government intends to introduce the Pension Fund Regulatory and Development Agency Bill in 2009. It is hoped that this Bill will provide sufficient incentives to voluntary participation in the NPS, and enable these funds to be channelled into infrastructure and other priority areas. Given India’s demographic advantage reflected in the rising working-age to total population ratio till about 2035, such savings can be an important avenue to mitigate the crowding-out effects of higher government expenditure.

Third, while the Budget has several positive features on the revenue side, these are not likely to assist in fiscal consolidation in the short term. The Budget abolishes the fringe benefit tax and commodity transaction tax. There is an assurance that the basic consensus on the goods and services tax (GST) has been reached among the Centre and the States. It promises a draft of the new income tax code within in 45 days, with enactment during the later part of 2009.

The emphasis in the Budget on lowering administration and compliance cost of taxation is also in the right direction. But, this will require restructuring the tax administration, with increasing focus on specialisation and professionalism of its staff. This should be backed by application of modern technology, and data mining capabilities.

India requires two major broad-based taxes: the income tax and the GST. Progress in this direction will provide greater flexibility and resilience to India’s tax system.

The construction of a modern tax system will, however, need to be integrated with civil service reform. It is hoped that the recommendations of the second Administrative Reform Commission set up in 2005 will be given much greater consideration and weight than has been the case so far.

Fourth, the Budget proposes significant increases in social sector schemes (such as those under the National Rural Employment Guarantee Act and under Bharat Nirman) and for infrastructure in both urban and rural areas. In particular, funds for Jawaharlal Nehru National Urban Renewal Mission have been increased by 87% to Rs 12,900 crore; and for the National Highway Authority of India by 21% to Rs 15,900 crore. The agricultural sector has also received well-deserved attention.

The focus of the Budget, however, is on increasing the outlays, without elaborating on the governance and delivery of services reforms emphasised in the President’s address to the Parliament on June 4, 2009. While there has been rhetoric about obtaining greater outcomes from given budgetary outlays, the political and civil service leadership to translate this rhetoric to measurable, visible progress has been lacking. 

The finance minister must realise that ever increasing outlays, without commensurate improvements in quality and quantity of public services, is a recipe for anaemic economic growth and high inflation. These adversely impact the aam aadmi the most.

Such improvements, in turn, will require greater urgency in budgetary reforms (for example, shift towards accrual budgeting, which will enable construction of both the income statement and the balance sheet must be accelerated); in greater competency in engaging in public-private partnerships; administrative reorganisation; much greater application of economic reasoning in design, implementation, and assessment of various government schemes; and more effective use of the skills and talents of the civil servants in carrying out their responsibilities.

India’s political economy and temperament is more suited to incremental, often decentralised piecemeal reforms. Perhaps, there will be greater clarity concerning fiscal reforms once the 13th Finance Commission submits its report in October 2009. Failure to mitigate the medium-term risks of the FY 2010 Budget will be a severe setback to the hopes of a rising India in the 21st century.

The writer is professor of public policy, National University of Singapore