The finance minister admitted, in his budget speech, that he had received two conflicting suggestions regarding fiscal deficit. One set of experts suggested that he stay on course in controlling the fiscal deficit. Another set of experts suggested some loosening in the same. The finance minister decided to follow the former advice and kept on track to attain reduction in the fiscal deficit to 3.5 percent of GDP. I agree with the second group. The idea of fiscal deficit being the road to growth is based on the assumption that economic stability will attract more foreign investments. This will not happen because the global economy is down. In this situation, the multinational corporations will not invest in India to manufacture for exports to their home countries.
The second factor behind the advice to control fiscal deficit is that an increase in expenditure will fuel government consumption and not in investments that are required to push the growth rate upwards. The burden of Rs 1 lakh crore due to the Seventh Pay Commission is staring in the face of the Finance Minister. Apprehension is that the increase in fiscal deficit will fuel such consumption. The apprehension is justified.
The Finance Minister did not have any choice. Increased salaries would anyways have to be paid to the government servants. The choice was limited to increasing fiscal deficit and protecting some public investment; or controlling fiscal deficit and killing the already meagre public investment. It is like the head of a family being addicted to drinking liquor and borrowing money for his bad ways. A reduction in the family budget to reduce borrowing in such a situation will only mean that books for the children and nourishing food for the pregnant daughter-in-law will be cut. Only a continuation of the borrowing will provide both for liquor and books for the children. The fact is that the finance minister cannot reduce government consumption, therefore, he cannot control fiscal deficit. It is a dead end.
There is still a way out though. Presently, the Comptroller and Auditor General (CAG) examines whether the government expenditures have been made as per budgetary allocations, whether the approval has been given by the competent authority and whether the tendering process was as per norms. The CAG does not examine whether the expenditures have led to desired impacts. As a result, many non-performing schemes continue to eat away the revenues of the government. The government must make a quick assessment of the impact of the myriads of welfare and development schemes that are in vogue. The finance minister has promised that “expected outcomes” will be mentioned in future proposals for expenditures. But there was a need to go harder. The bottom one-third of the schemes should be closed and allocations for the top one-third of the schemes must be doubled. This would have led to a vast improvement in the quality of public expenditures and jumpstarted the economy. The finance minister failed to take this hard action.
The second possible step was to overhaul the welfare state. The Union Government is spending about Rs 600 lakh crores in various welfare schemes like food subsidies, LPG subsidies, fertiliser subsidies, health, education, and a host of smaller welfare schemes. The government is also taxing diesel at low rates as a measure to keep transport costs low and provide relief to the people. Most of these subsidies do not reach the poor though they are justified in their name; Rajiv Gandhi had famously said that only 15 paise of the rupee sent from Delhi reached the intended beneficiary. Most of these subsidies support corrupt bureaucracies of organisations like the Food Corporation of India; or the richer people of the country. For example, the benefit from the lower cost of diesel is largely captured by the SUV owners. The finance minister could have taken a bold step and killed all these schemes. The 600 lakh crores being spent on these schemes could be directly transferred to the accounts of the 25 crore households. Each household can be paid an amount of Rs 2,000 per month from this money. That way a huge demand for consumption would be created. Presently this money is being paid to government servants who invest the money in real estate and gold. These payments are not generating demand for goods like clothes and bicycles in the economy. A huge demand would be generated by cash payments to the households and would have put the economy on a fortuitous cycle of demand followed by investment and production.
The third step that could be undertaken by the finance minister was to pay out the increase in salaries to the government servants in the form of bonds such as of the National Investment and Infrastructure Fund. These bonds could be locked in for a period of 10 years. The same money would then achieve two objectives. It would somewhat placate the government servants that increase in salaries is deferred rather than denied. Secondly, it would provide a big push to public investment in infrastructure.
The crux of the problem is that hands of the finance minister were tied. An increase in government consumption due to the Seventh Pay Commission was inevitable. The finance minister will be forced to borrow more only to make these payments. The tax proposals outlined by the finance minister only suggest an increase in revenues of Rs 19,000 crores. This is not even one-fifth of the expected outgo on account of the Pay Commission.
The only solution in this tight situation was to make a drastic improvement in the quality of government expenditure.
The way forward was to allow fiscal deficit to increase and improve the quality of government expenditures. The finance minister has lost the opportunity to make these changes. One may safely predict a lacklustre performance of the Indian economy in the coming years.
(Author was formerly Professor of Economics at IIM Bengaluru)
