Thursday, 24 November, 2022
HomeOpinionIt's time to forget the 3% target for fiscal deficit

It’s time to forget the 3% target for fiscal deficit

There's no great virtue in stipulating that 3% of GDP is the desired level of fiscal deficit. India, with its faster economic growth rate, can cope quite well on all indicators with a higher deficit.

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The time may have come to bid goodbye to the law on fiscal responsibility, because it is doing more harm than good. No deficit target set under the law has been met in any year, except perhaps once in 2007-08. Target years for reaching the desired fiscal deficit (3 per cent of gross domestic product) have been pushed back constantly, or “paused”.

The compounding problem is that, when finance ministers have been unable to get even close to the targets, they have fudged the books and pushed the fiscal burden on to hapless public-sector entities, whose treasuries have been raided in more ways than one in the effort to close the reported gap in the government’s numbers. One result is that oil companies that were once cash-rich are left with little cash of their own to invest.

Other tactics to show adherence to targets under the fiscal responsibility law have included not paying bills (note the minister’s recent instruction that overdue payments to small and medium enterprises should be made immediately — which implicitly leaves out the rest though their money too is overdue). Alternatively, tax officials under pressure to deliver revenue numbers have coerced companies into paying up excess tax in the closing month of the year on the promise of a refund early in the next year. And yet, despite such tactics, the deficit numbers have remained stubbornly out of line. Anyone in doubt about the real picture should read what the Comptroller and Auditor General told the Finance Commission: That the Central deficit was not 3.46 per cent in 2017-18 as Parliament has been told, but a much higher 5.85 per cent.

Why do we make finance ministers go into such contortions to tell us that near-6 per cent is 3.5 per cent? Why not encourage more open and full accounting so that the country knows the real picture?

Under-reporting the real deficit encourages key people in governments to believe that they can afford to spend more, when in reality they don’t have that cushion. Correctly reported numbers, with their warning lights flashing, would (hopefully) encourage a greater sense of fiscal responsibility. If nothing else, private-sector economists, rating agencies, and the like who today parrot the government’s version of the deficit would tune into a very different reality — and build market pressure for fiscal correction.

Also read: Modi govt needs to stop claiming it lacks data on the informal sector, it doesn’t

Dispensing with the fiscal responsibility law by itself is not enough, for fudging went on even before such a law existed. Scrapping the law has to be combined with other changes to make fudging difficult. One is to move away from the current, archaic system of cash accounting that most countries have given up.

Cash accounting leaves out of the books the expenditure that the government has undertaken but not yet paid for (e.g. payments to infrastructure companies for work done on roads, bridges, and the like). Most companies account in their books for the money owed to creditors; the government does not, and gets away with it by following the cash-accounting method.

The other, complementary step would be to provide a fuller account of public-sector borrowings. This would bring into the open the expenditure that the government currently pushes on to entities it owns — like the Food Corporation, which has borrowed from small-savings funds to pay for the food subsidy that should have been funded through the Budget.

Even if these changes don’t deliver credible budgeting, there is no great virtue in stipulating that 3 per cent is the desired level of fiscal deficit at the Centre. As T.C.A. Srinivasa-Raghavan has argued more than once in these pages, that number was simply copied from the European figure, although the economic context for India is radically different from that in Europe.

It is entirely plausible, for instance, that the Indian system with its faster economic growth rate can cope quite well on all the usual macro-economic indicators with a higher deficit — even if not one that is quite as high as what exists now. Such questions cannot begin to get addressed in a world of real numbers till everyone knows the truth about the deficit.

By Special Arrangement with Business Standard

Also read: Modi Govt sees Rs 1.6 lakh cr tax shortfall, deficit 3.9% of GDP leaving fiscal hole


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  1. Modi must now take some bold political decisions on economy and remove all cobwebs of past 70 years of economic management. One of the decisions is about complete transparency in accounting for fiscal deficit and its impact on inflation, without specifying any hard target for fiscal deficit. In addition, as Ninan argues, we must change cash accounting to accrual accounting method as well to show the correct position. Fiscal deficit is the result of various government policy actions on letting go revenues and increasing spending for running administration, social sector and capital investment and hence, component and quality of spending matter not the deficit target itself. A economy grows, deficit will correct itself to its natural level and we learn to live it. Government should have a strict target for its administration cost as a percentage of tax collected and live within it strictly by improving efficiency, retiring incompetent staff at all levels etc. Interestingly, if actual fiscal deficit is 6%, and we are still able to manage inflation under 4% shows that we need be too scared of this number ! Modi style is objective oriented management- particularly when the objective has a strong nationalist sentiment- so let the objective be how to reduce India’s trade deficit with India’s enemy No 1- China to zero level from the current level of USD 60 billion. To achieve this, we must reduce bring cost of our goods and services to the level where it is competitive with the Chinese- so reduce direct and indirect taxes, improve infrastructure, introduce labor reforms, become business friendly etc. To do this means to do many things one of them is about this issue of FRBM Act. Having sorted or about to sort various long pending contentious political issues of the country (Art 370, UCC, Ram Mandir, one election, removal of word secularism from the Preamble of the Constitution etc etc.) , the real legacy of Modi will be his footprint on the economic management. If he is serious about India becoming 5 trillion dollar economy, he must make bold political decisions. Should Amit Shah move to finance ministry after the December session of Parliament after introducing bills for UCC and Ram temple construction?!!!

  2. Chastity for a woman is good. Also for a man. Period. Simply because we have made a dog’s breakfast of the fisc is no reason to argue against the FRBM Act or the reasonable figure of 3%, which in any case excludes an equal figure for the states. We are actually closer to 10%. Nor should we believe this fairy tale that our higher growth – remember fastest growing economy in the world ? – gives us a free pass. 2. The government should get its fiscal house in order. It is sapping the real economy of vitality. Nor is its profligacy building shiny new airports. Like many given to banks for recap, down the chute.

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