ECONOMIC NOTES

Fiscal Responsibility Versus Democracy

 Jayati Ghosh

ONE of the first undertakings of the UPA government --- and indeed its first legislative action --- was to notify the second bill --- the Fiscal Responsibility and Budget Management Act (henceforth FRBM Act). This act was notified on July 2, to come into force on July 5, 2004, only three days before the presentation of the Annual Budget, thereby making circumscribing the entire budgetary exercise from the start of the new government’s tenure.

The FRBM Act is apparently well intentioned, designed to clean up public finances and put them on a sustainable footing. Thus, it requires the reduction of the fiscal deficit and the elimination of the revenue deficit of the central government by March 31, 2008 (the deadline is to be extended by a year). This would appear to be a way of forcing the government to adhere to a discipline, which would thereby allow it to spend more on useful capital expenditure.

ACTUAL IMPLICATIONS

However, the actual implications of the working of the Act are much more serious and potentially adverse, than is generally understood. The Act requires the central government to reduce the fiscal deficit by 0.3 per cent of GDP each year, and the revenue deficit by 0.5 per cent each year, beginning with this financial year. If this is not achieved through higher tax revenues, the necessary adjustment has to be made by cutting expenditures.

Further, the Act prohibits the central government from borrowing from the Reserve Bank of India (that is deficit financing, involving the printing of money) to meet its deficit, except for temporary cash advances. This effectively rules out a cheap source of borrowing and forces the government to borrow at much higher rates, for no evident reason.

The argument that deficit financing causes inflation is not just simply wrong. It is now widely acknowledged across the world to be ridiculous and completely unwarranted, especially in the financially sophisticated world we live in. So inflation control does not at all depend upon controlling the central government’s borrowing directly from the RBI.

So this directive does not serve any useful purpose. Instead, it unnecessarily forces the government to pay much higher interest on all its debt, instead of allowing for some low interest debt to the RBI. This raises the interest cost of the government and thereby the total revenue expenditure, perversely making it harder to achieve the revenue deficit targets. It is hard to understand why this portion of the Act has been retained even when earlier discussion in parliament pointed to the absurdity of this condition,

MOST WORRYING PART OF THE FRBM ACT

But the most worrying --- and potentially undemocratic --- part of the FRBM Act relates to compliance conditions. The notification spells the requirements all too clearly: “In case the outcome of the quarterly review of trend in receipts and expenditure…at the end of any financial year… shows that

1. the total non-debt receipts are less than 40 per cent pf the Budget Estimates for that year; or

2. the fiscal deficit is higher than 45 per cent of the Budget Estimates for that year; or

3. the revenue deficit is higher than 45 per cent of the Budget Estimates for that year,

 then… the Central Government shall take appropriate corrective measures.”

This means that if any of these conditions holds (which is very likely in most years) the government will in effect be forced to cut expenditures even if they are essential for the economy, or required to enforce its popular mandate or to deliver the socio-economic rights of the citizens.

This is going to hit home much faster than many people realise. The Budget 2004-05 contains what are widely recognised to be inflated and highly optimistic revenue receipt projections. Also, the overwhelming part of additional resource mobilisation in the budget is back loaded, to be available only after September. In addition, the truant monsoon is bound to depress revenues.  By September, it is not just likely but almost inevitable that the actual revenue receipts will fall short of the Budget estimates by 40 per cent or more.

When that happens, by the Act that the government has just notified, it will then be required to cut back on expenditure. This means that even the low and inadequate provisions for employment, education and other goals listed in the National Common Minimum Programme will be further cut, and may not even increase at all.

Much of the opposition to the expenditures projected in the Budget has focussed on the low additional outlays for critical and socially necessary areas, which has been seen as a betrayal of the people’s mandate. The total budgeted for these is only Rs 10,000 crore, but imagine the situation if even this small additional outlay is not actually provided, because of the constraint posed by the FRBM Act!

WORSE TO COME

There may be even worse to come. The fearsome combination of heavy floods and severe drought that is affecting different parts of the country is bound to involve lower incomes and thus lower tax collections, as already stated. But it should also require much larger outlays to provide even the most minimal relief to the affected people who are spread across India. Even such critical relief and rehabilitation --- including in the form of rural employment and other physical assistance --- may be under threat from the absurdly rigid fiscal discipline imposed by the Act.

Across the world, the problems with such fiscal responsibility legislation across the world are now becoming more and more evident. In US and the European Union, governments are seeking ways to get around such laws, which have become a burden and a constraint upon necessary economic policies.

Clearly, therefore, this is not just a foolish piece of legislation but also fundamentally undemocratic and possibly even unconstitutional. The new government should without delay enter into a reconsideration of this Act, with a view to repealing it, if it is to remain responsive and accountable to its citizenry, rather than following the dictates of the highly dubious economic logic favoured by international investors.