Fiscal Responsibility: The Debate

Topics: Keynesian economics, Public finance, Monetary policy Pages: 10 (3297 words) Published: January 4, 2014

Fiscal Responsibility - the Debate

1.There is, by definition, a tension between fiscal restraint and finding resources for all the expenditure needs of the government. Where this line is drawn and how this tension is managed is the stuff of much economic analysis as well as ideological debate. The Fiscal Responsibility and Budget Management (FRBM) Act mandates the Centre to have reduced fiscal deficit to 3% of GDP and to completely eliminate revenue deficit by 2008/09. Similarly, acting in response to the debt relief package recommended by the Twelfth Finance Commission (TFC) in return for fiscal correction, 24 of the 29 states had also enacted fiscal responsibility acts accepting similar obligations - fiscal deficit of 3% of Gross State Domestic Product (GSDP) and zero revenue deficit by 2008/09. The case for fiscal responsibility, both at the Centre and in the States, was made on the argument that fiscal consolidation is an essential condition for accelerating growth.

2.Some economists and critics have called into question the advisability of fiscal restraint when the public sector investment needs are so large and pressing, and have contended that in the Indian context, it is not fiscal contraction, but fiscal expansion that is growth enhancing. The Approach Papers to the Five Year Plans since have also made out a case for relaxing the FRBM targets in order to find sufficient resources for the ‘gross budgetary support’ (GBS) that the Plans demand.

3.This Paper will argue that staying the course and delivering on the FRBM targets is critical to sustaining the current growth momentum. The bedrock of sustainable growth is macroeconomic stability. Maintaining macroeconomic stability, as characterized by low inflation, stable interest rates and comfortable balance of payments, is critically dependent on redressing fiscal imbalances.

4.Three important qualifications on the way forward to fiscal responsibility are in order. First, there needs to be fiscal correction not just at the Centre but also in the states. Second, for sustaining and accelerating growth, achieving the FRBM targets is necessary, but not sufficient. We need to pay attention not only to achieving the targets in quantitative terms but also to the quality of adjustment. In particular, this will mean improving both the allocative and technical efficiencies of public expenditures. Third, a stand-alone deficit target is incomplete unless the level of revenue or expenditure is specified too. Given that fiscal deficit is the gap between the government’s revenue and its expenditure, a given level of deficit can be achieved at different levels revenue and expenditure. It is important that these levels are maintained sufficiently high even as we target a specified fiscal deficit.

Post - Reform Trends in Deficits

5.To put the fiscal responsibility debate in perspective, it is important to take stock of the trends in fiscal and revenue deficits in the post-reform period.

6.Public finances, both at the Centre and in the states, have deteriorated progressively since the mid-90s. The combined fiscal deficit of the Centre and the states which was 9.3% of GDP in the crisis year of 1990/91 dropped to 6.3% in 1996/97 before creeping back up to 9.0% in 1998/99 largely on account of the impact of the Fifth Pay Commission award. The fiscal deficit had remained at over 9.0% until 2002/03 and has since been on a downward shift declining to 7.5% in 2005/06, stands currently at 5.9% and is expected to further reduce to 5.1% during the fiscal 2012-13. Similarly, the combined revenue deficit of the Centre and the states which was 4.2% in the crisis year of 1990/91 and had declined to 3.2% by 1992/93, grew to an alarming level of 6.9% by 2001/02. Like fiscal deficit, revenue deficit too has shown a welcome downward shift.

7.The net picture that emerges is of a short- lived...
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