Goodbye to prudent fiscal management

The Union Budget 2018-19 has in many ways dishonoured prudent fiscal management and thereby has bid goodbye to the idea of fiscal governance. First, the revenue deficit target has been done away with in the proposed new FRBM architecture.  This is a body-blow to one of the biggest reforms that reined in government profligacy, a measure that set the nation to a long-term path of sustainable financial management. The new fiscal architecture suggests that revenue expenditure is as important as capital expenditure, which essentially says the government sees no distinction between (unproductive) consumption expenditure and (growth inducing) asset creation expenditure. In this new framework, capital expenditure does not enjoy pre-eminence.

There is a higher dependency on surplus transfer from the RBI. This carries the potential of weakening the RBI balance sheet on the one hand and financing unproductive expenditure on the other. These markers apart, there  are  big  questions on (a) budget integrity in terms of fiscal slippages in 2017-18, (b) pattern on financing the fiscal deficit, (c) the wherewithal in financing allocations to many flagship programmes as also operational feasibility of these schemes, and above all (d) the move to a higher growth trajectory of eight per cent.

The revenue deficit as a percentage of GDP is budgeted at 2.2 per cent. This implies that not only about 66 per cent of the net borrowings of the government (fiscal deficit) will be pre-empted for current consumption (which is a strict violation of fiscal prudency) but it also translates in to a dis-savings of the government...

The Union budget 2018-19 has a size of Rs.24.42 trillion, comprising a revenue component of 87.7 per cent and the balance 12.3 per cent for capital expenditure. Net of defence, the capital expenditure accounts for 7.6 per cent of the total expenditure. On the revenue expenditure front, budgetary spending on interest payments, food subsidies, pension and defence nearly account for 50 per cent of total revenue expenditure. Again, net of grants to States and UTs, the revenue expenditure of the Centre which can be said to be pushing growth (as the new fiscal architecture is clamouring for) could be at best 30 per cent. Adding the capital component, the total growth inducing expenditure, spending that could act as a catalyst for growth, is estimated at 37 per cent. Thus, from the expenditure side, it is hard to believe that the expenditure composition has potential for a growth of eight per cent.

The above argument is also corroborated from the predominance and persistence of the revenue deficit at a higher level. The revenue deficit as a percentage of GDP is budgeted at 2.2 per cent. This implies that not only about 66 per cent of the net borrowings of the government (fiscal deficit) will be pre-empted for current consumption (which is a strict violation of fiscal prudency) but it also translates in to dis-savings of the government to the extent of 2.2 per cent of the GDP..

...the revised FRBM architecture having no respect for eliminating revenue deficit is a huge long term loss and strikes at the root of fiscal governance.  To the extent the credibility of fiscal management is a big question mark, any other announcements relating to agriculture, rural development, health education , employment, MSME and infrastructure sector remain ornamental and symbolic.

In a scenario when gross financial savings are at the downward swing, this development is a matter of serious concern for fiscal governance and also for growth. In this context, it is also important to mention that the revised FRBM debt target to bring the debt to GDP ratio from the budgeted level of 48.8 per cent to 40 per cent will not be achieved as long as the government is borrowing for current consumption. This is also evident in the medium term fiscal policy statement, which has set out that the government will only bring the debt to GDP ratio to 44.6 per cent by 2020-21.

The argument that growth will be stimulated largely by domestic private sector investment and foreign direct investment sounds well in a textbook sense. In practice, both have limitations. The former is constrained by higher government borrowings (Centre, State and local) crowding out private investment available by pre-empting the financial savings and putting pressure on the interest rate. The latter is constrained by the sustainability of the Current Account Deficit (CAD).

One critical issue in this regard is the budgeting of the financing of the fiscal deficit and more importantly monitoring the financing of the fiscal deficit. There are two ways the domestic component of the fiscal deficit could be financed: market borrowing (both dated securities and treasury bills) and non-marketable borrowing (Provident Funds, small savings etc.). According to the constitution, the former is named the Consolidated Fund borrowings and latter is known as Public Account borrowing. Monitoring is important because in the event the small savings and provident funds for some reasons increase, the market borrowing could be reduced. Otherwise, the government will over borrow and maintain a cash surplus with the RBI. Evidence suggests that the cash surplus with the RBI is becoming a rule rather than exception. The weak and inefficient cash management will hinder the debt management and liquidity management by RBI.

Illustratively, Budget 2018-19 has accounted for an amount of Rs. 43,066 crore as a drawdown of cash balance. This is again a violation of prudent fiscal management as the prudent fiscal norm is provision of a zero cash balance in the budget estimate.

Monitoring is important because in the event the small savings and provident funds for some reasons increase, the market borrowing could be reduced. Otherwise, the government will over borrow and maintain a cash surplus with the RBI. Evidence suggests that the cash surplus with the RBI is becoming a rule rather than exception. The weak and inefficient cash management will hinder the debt management and liquidity management by RBI.

The revenue receipt side of the budget 2018-19 has estimated a Gross Tax Revenue (GTR) to GDP ratio at 12.13 per cent with a calculated tax buoyancy of 1.45. In this context, it is pertinent to note that GST at Rs.7,43,900 crore (projected realisations for 2018-19) accounts for around four per cent of the GDP and about 33 per cent  of GTR. While GST is a welcome move and a game changer in our taxation system, this heavy reliance on GST, which is an indirect tax, will make the taxation system regressive. Already this trend has set in the Budget for 2018-19 with a share of 50- 50 per cent ratio of direct to indirect tax. This is also against the prudent fiscal management. The sooner we move to a progressive taxation system with a higher share of direct tax, the better.

The optimism set out with regard to disinvestment receipts at Rs. 80, 000 crore lacks some fiscal transparency as the break ups into various components like equity selling, strategic disinvestment and others (as given in the budget for 2017-18) are not provided.

To conclude, the revised FRBM architecture having no respect for eliminating revenue deficit is a huge long term loss and strikes at the root of fiscal governance.  To the extent the credibility of fiscal management is a big question mark, any other announcements relating to agriculture, rural development, health education , employment, MSME and infrastructure sector remain ornamental and symbolic.