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Great if the numbers add up

March 2, 2008

Rajiv Kumar, Director and Chief Executive, ICRIER, Member, National Security Advisory Board and part-time member, TRAI
“The catch is surely in the underestimation of expenditures, which are estimated to increase by merely 6 per cent. Correct this underestimation and the fiscal deficit rises to be closer to 5 per cent”

Rajiv Kumar
In presenting the budget for 2008-09, Finance Minister P. Chidambaram seems to have achieved the impossible. He did not give up any of the ongoing schemes or subsidies; in fact, allocations for most of them have been enhanced. He announced tax cuts both for direct and indirect taxes; handed out a $15-billion (Rs 60,000-crore) loan waiver for marginal and small farmers; and yet, achieved a fiscal headroom by bringing down the fiscal deficit next year to 2.5 per cent of GDP instead of the 3 per cent required by the Fiscal Responsibility and Budget Management Act (FRBMA).

In doing all this, he must have earned well-deserved gratitude of his party president; left the Opposition practically speechless and in barely disguised envy; and challenged the economists and other assorted critics to try and find the weaknesses. Can all this be for real or is there an inevitable catch or the sleight of hand?

The catch is surely in the underestimation of expenditures, which are estimated to increase by merely 6 per cent. Correct this underestimation and the fiscal deficit rises to be closer to 5 per cent. First, the off-Budget items like the interest on oil, food and fertiliser bonds, which the Finance Minister has to his credit made transparent, will add at least 1-1.5 per cent of GDP to the fiscal deficit. Second, the fiscal costs of the Sixth Pay Commission award have not been factored in; Third, the Finance Minister has promised for both defence and the National Rural Employment Guarantee Scheme (NREGS) more funds if needed. Fourth and perhaps most importantly, the method for financing the farmer loan waiver has been left unclear.

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The Finance Minister left this unclear even in his post-Budget interviews. The stock market, after an initial thumbs down, perhaps realised that these costs will come out of the fisc and recovered partially. If this be the case, the FRBM targets, both for fiscal and revenue deficits, will be grossly violated.

I have not been an avid supporter of the fiscal deficit target under FRBM if only for the reason that it has never been explained to me as to what is the economic or any other basis for the 3 per cent figure except that it was part of the Maastricht treaty! I have found it rather presumptuous on part of economists and sundry professionals to try and take away the needed degrees of freedom from political leadership who are accountable for the economy’s health. But either we have the targets and adhere to them or else decide to jettison them and not carry on with the charade.

It would be far better and productive to focus attention only on bringing the revenue deficit down to zero as soon as possible. No government or a firm or household can afford to live beyond its means (barring a loan waiver or two!). This focus on revenue deficit will put an end to the continued revenue profligacy of successive governments and their disinterest in bringing down interest payments by retiring the existing public debt by mobilising capital receipts.

The Finance Minister has been charged with letting the politics ride rough shod over sound economics and succumbing to the worst populist pressures. I beg to differ on at least three important counts. First, the farmers’ loan waiver represents a neat and clear cut transfer of income to a distressed class of people and addresses a problem which if left unaddressed, could lead to systemic distress and failure. If my puritan friends do not object to recapitalisation of public sector banks in China or of hedge funds in the US, or to the recent nationalisation of Northern Rock Bank in the UK, they should appreciate this as well. Second, the cut in Central excise from 16 per cent to 14 per cent and further in the case of some sectors (except cars) and the raising of the exemption limit for income tax is sound economics when faced with an uncertain external environment and the need to shore up domestic demand. Third, the greater allocations for education (20 per cent), health (15 per cent) and to rural infrastructure, irrigation schemes and skill development through scholarships and upgradation of ITIs may look like populism but are necessary measures for addressing emerging constraints on growth. I only wish the Finance Minister will also take the courage to initiate necessary reforms in these sectors.

There are, however, some areas of expenditure which I wish the Finance Minister had put to better use. The first is the additional Rs 16,000 crore with promises for more, for NREGS. This scheme will now be rolled out in all 596 districts despite the fact that even Rahul Gandhi has questioned the benefits from it for actual beneficiaries. This expansion is completely incomprehensible because in Uttar Pradesh and Haryana, where I have had the occasion to visit some villages and see the implementation, it is clear that the outlays have been largely leaked. Why not use these substantial resources to accelerate the construction of all-weather roads, deepen ponds, rehabilitate and expand the village schools and give scholarships to village children. All these have much bigger and sustained poverty reduction impact. The other public sector outlays that will never achieve the desired results and are, in fact, creating serious distortions are the fertiliser and petroleum subsidies. These are now dysfunctional and resulting in destroying agriculture lands and our environment. These outlays make for both bad politics and worse economics because they don’t even result in electoral support.

For me this Budget has two nuggets hidden deep under all the hoopla on waivers and tax cuts. I refer to the Finance Minister’s announcement on starting a pilot scheme for the use of smart cards in the public distribution system for food in Haryana and Chandigarh. I take some immodest pride in having developed the idea, which I heard first from Azim Premji, presenting this to the Finance Minister and to the Secretary, Department of Economic Affairs (DEA), when I was Chief Economist for CII. I saw it progress through the Planning Commission, through to the DEA’s feasibility study supported by the World Bank to this pilot phase. This can be historical.

If successful, and there is no reason why it should not be, it will cut at the very root of large-scale public sector corruption and inefficiency. I do hope the Finance Minister will entrust its monitoring to a non-government task force to ensure its success. I volunteer.

The second nugget is the establishment of the Plan Schemes Monitoring System in the Planning Commission. This can make the difference between outlays being turned into actual outcomes as intended under the schemes. This is a real step in the direction of performance-based budgeting. Again this can be the beginning of something really big.

Finally, I have to thank the Finance Minister for my winning a bet that not even one of the reform measures listed in the by now famous Box No 2.2 on page 25 of the Economic Survey, will find mention in his speech. I hope the gentleman concerned will pay up! In the ’60s and ’70s, there used to be a joke that the Congress party generally signals left and turns right to avoid detection of reforms. Box 2.2 and the Budget speech are a case of signalling right and turning left! How times have changed.

Rajiv Kumar is Director and Chief Executive, ICRIER, Member, National Security Advisory Board and part-time member, TRAI

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