Unfortunately, FRBM is not a fiscal transparency Act

Fiscal deficit really amounts to 3.11 per cent of GDP, not 2.5 per cent as professed. Surprised? "Don't be, as these are fiscal costs of budgeting for elections," explains Dr D. K. Srivastava, Director of the Madras School of Economics, in a tˆte-…-tˆte with Business Line, a few hours after the Union Budget 2008-09.
While we regale amongst the newfound tax incentives doled out by the Union Finance Minister on February 29, it may be worth sparing some time to look at the financial health of the Government itself, stirring up the `everyday economist' that resides within each of us.
"It is well known that according to the Centre's Fiscal Responsibility and Budget Management (FRBM) Act, the revenue deficit was to be brought down to zero and the fiscal deficit relative to GDP (gross domestic product) was to be contained at 3 per cent...Alas, both targets have been missed," reveals Dr Srivastava.
The more we dissect the Budget, the more intriguing it can be, making us wonder if there is a veritable whitewash that has been going on in the name of complying with the FRBM Act.
Excerpts from an e-mail interview:

On Budget day, the FM said fiscal deficit target has been achieved.
As per the Budget estimates, the revenue deficit of the Central Government remains more than Rs 55,000 crore amounting to 1 per cent of GDP although the fiscal deficit target is overachieved, estimated at 2.5 per cent of GDP.
This, of course, does not take into account the off-Budget borrowing by the Government. The correct measure of fiscal deficit is to look at the change in Government liabilities, which amounts to 3.11 per cent of GDP. This means that both targets of the FRBM Act have been missed.
But how could that happen when we have the FRBM Act?
Both revenue and fiscal deficit numbers are underestimates and will become larger through both the expenditure and revenue sides of the Budget.
Unfortunately, our FRBM Act is not a `fiscal transparency' legislation,; otherwise else it would not have been possible to get away with no clear accounting of costs of giveaways without clearly making a Budget provision.
What about the effect of an expenditure such as the farm-loan waiver?
In the case of the loan waiver for the farmers, if the cost per year is Rs 20,000 crore and running to for the current and two more succeeding years, it will add a corresponding amount to both the fiscal deficit and revenue deficits each year. Fiscal deficit will increase because money will need to be borrowed on- or off-Budget, and as also the revenue deficit, because it will have to be given as grant to the concerned banks concerned. Both can be kept off the Budget but will be real costs.
Those are huge numbers. And we have the Sixth Pay Commission also.
Yes, the additional salary burden after the imminent recommendations of the Sixth Pay Commission will have to be brought into the Budget explicitly. Since only normal increases in the salary and pension estimates have been provided, there is a clearly an understated expenditure head round the corner.
What kind of numbers are we talking about here?
The Budget estimates for salaries of government employees, including allowances and pensions, amount to nearly Rs 77,000 crore. An increase by a factor of 20 per cent will imply an additional revenue expenditure of more than Rs 15,000 crore. In all probability, the factor of increase could well be more than 20 per cent.
What effect could there be from the Government overachieving one target, while missing the other?
Under-achieving the revenue deficit targets while overachieving the fiscal deficit target by the FM left too little room for augmenting capital expenditure. With 1 per cent of GDP as revenue deficit, keeping 2.5 per cent of GDP as fiscal deficit implied that capital expenditure could amount only to 1.5 per cent of GDP. Defence spends were hiked by 10 per cent.
With defence capital expenditure also going up, the natural outcome has to be a sharp fall in non-defence capital expenditure. A better counter-cyclical strategy would have been to adhere close to the revenue deficit target and breach the fiscal deficit target insisting upon a massive increase in infrastructure expenditure.
A conscious increase in infrastructure capex could have helped?
Not only does this add to demand but also lightens up the supply side pressure and helps make exports more competitive by reducing operational costs. In the end, we have to rely more on the `luck' of the Finance Minister rather than any hard arithmetic.
The Government said income-tax cuts were revenue neutral. Do you agree?
Yes, the adjustments in the income-tax slabs have been taken as revenue neutral. The number of income-tax assessees in India is about 3.15 crore. Most estimates of the benefit of the slab adjustment put it in the range of at Rs 25,000 or more. Even if we consider that this would apply to less than half the number of assessees, there is going to be a clear cost anywhere in the range of Rs 25,000 crore or more.
So the problem is with number of assessees.
Yes. It would have been fiscally far more transparent to undertake detailed estimates of the costs of the slab adjustments to the exchequer. To be fair to the Finance Minister, we should recognise that the buoyancy of income-tax in the preceding two years was 2.2 and 4.3 and this year he has assumed only a buoyancy of 1.3.
What drives buoyancy?
Two factors are responsible for these surges in buoyancy. One was a significant improvement in buoyancy based on enhancement in compliance linked to much better information management.
The second was the imposition of additional surcharges. Both effects are part of the base number; any additional growth will be normal growth now, which is likely to show up a buoyancy of more than 1.3. Anything that can add up to the financial pain.
The impact of the reduction of core Cenvat rate from 16 per cent to 14 per cent has also not been provided for. The assumed growth rate is roughly close to the average of growth of the last two years. There is clearly going to be revenue erosion in the Union excise duties. Taken together, there is going to be additional revenue and fiscal deficit of about 1- to 1.5 per cent of GDP.
But why wait to do all this in 2008?
With several States also going in for elections in this or the next year, competitive politics will lead to a proliferation of giveaways. Parties will compete with each other for designing bigger and more innovative packages wherever elections are forthcoming.
They will also not hesitate in implementing salary revisions as soon as the report of the Sixth Pay Commission becomes available. It will take no more than one year to erode the hard-earned balance or surplus on the revenue account of the States. The Centre has inadvertently sent very adverse signals by breaching the FRBM Act.
The effect, however, remains largely `Centre-centric' doesn't it?
Any and every State will quote the precedent and breach its respective FRBM Act targets if circumstances so warrant. Additional subsidies, tax exemptions, and generous salary revisions, independent of their respective fiscal positions are all ways in which competitive politics will play itself out. The long-term estimates put the fiscal cost in terms of additional revenue and fiscal deficits at 1 per cent of GDP preceding the general elections in the country. That looks like the cost emanating from the central Budget alone this time round.
What about the extra money coming into people's hands?
The strategy of putting additional spending power in the hands of people is a tactic aimed at augmenting demand to cope with the impending slowdown. Since there has not been an explicit interest rate reduction, clearly greater reliance is being placed on fiscal stimulus rather than monetary measures.
Government has allocated lots of funds to important sectors such as education and health.
There is hardly any increase in total Government expenditure, which is budgeted to grow at 5.85 per cent. This will only cover inflation, and there is hardly any increase in real terms. The reason is that while revenue expenditure is slated to increase, capital expenditure falls. In fact, revenue expenditure shows a growth of 11.8 per cent while capital expenditure falls by 23.2 per cent.
Any numbers that you can share. Capital expenditure falls in absolute terms from Rs 1,20,787 crore to Rs 92,765 crore. Of this, non-defence capital expenditure falls even more. Non-defence capital expenditure is less than 1 per cent of GDP.
For an economy such as ours, faced with chronic infrastructure deficiency, this is neither appropriate nor a suitable policy for fighting stagflation. Faced with inflation that is structural in nature, far more effort is needed to augment investment rather than consumption demand, which also comes only indirectly through the loan waiver and tax concessions. Demand augmentation is inadequate and does not rely on augmenting investment demand. There is no effort to support exports through fiscal measures.
What if there is a larger revenue deficit than stated?
If there is a larger revenue deficit, considering the Centre and States together, there will be a fall in public sector savings that had turned positive after the complete insistence on the FRBM targets.
An overall erosion of about 2 percentage points is quite likely. There is also going to be some fall in corporate sector savings given that the economic slowdown and consequent impact on profits.
Any effect on growth?
It is well known that household savings have been stagnant in the last few years and most of the increase in the savings rate came from the Government and the corporate sector.
There will be a consequent erosion of the growth rate, which could well be in the range of 7 to 7.5 per cent rather than 8 to 8.5 per cent. Any fall in the growth rate will further erode revenues.

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D. Murali Kumar Shankar Roy Thursday, 06 March , 2008, 13:23