How Pranab painted a rosier picture

By: | Updated: 19 Mar 2012 10:08 PM

This must rank as the Godzilla of all fudges played out in this
country in the guise of fiscal consolidation.

Finance minister Pranab Mukherjee has quietly dumped his commitment to
eliminate the Centre's revenue deficit — at least the real McCoy, which
has traditionally been defined as the excess of revenue spending over
revenue earnings.

It's a commitment that every elected government in office since 2003 has
sworn to achieve under the Fiscal Responsibility and Budget Management
(FRBM) Act.

Mukherjee has chosen instead to do two things: first, he has created a
hugely watered-down proxy target called the "effective revenue deficit"
and, second, stretched the time schedule for its elimination by six years
to March 31, 2015.

The effective revenue deficit — a new measure that the government
started reporting from last year's budget — strips out a portion of
revenue expenditure that has been re-classified as grants for the creation
of capital assets.

It was never clear why he had started reporting the new metric last year.
Now it is.

"The concept of the effective revenue deficit, introduced in the last
budget, to address the structural imbalances in the revenue account, is
being brought in as a fiscal parameter," Mukherjee said in his budget
speech last Friday.

The government had never classified revenue expenditure as a grant for
creation of capital assets until last year.

Elevating the new reporting metric to a fiscal parameter now is a subtle
trick that the government has used to depress its revenue deficit
reduction target under the FRBM Act by almost 47 per cent.

Mukherjee did not, however, explicitly state this in his budget speech as
it might have sparked off a caterwaul of protest over the government's
move to duck its commitments. He said his aim was to "strike a balance
between fiscal consolidation and strengthening macroeconomic fundamentals
to create adequate headroom to deal with future shocks."

Mukherjee isn't coming upfront with this fiscal fudge: he has tucked it
into a corner of the Finance Bill 2012. When and if Parliament passes the
bill, it will automatically gain its approval. It is unlikely that there
will be any discussion on this issue in the budget debate where members
move cut motions.

The government doesn't on its own have the numbers in the Lok Sabha to see
the bill through. That could explain why it has reached out to Mamata
Banerjee and her Trinamool Congress. It is a lot easier to give up the
pawn — Dinesh Trivedi in the railway ministry — than jeopardise the
passing of the Finance Bill. The government will collapse if the bill
fails to pass and it will also lose out on the opportunity to hammer down
the size of the deficit that needs to be eliminated.

Redefining deficits
When the budget was presented in February
2010, there was no mention of the effective revenue deficit. That came in
the following year. While doing so, Mukherjee worked the concept backward
by a year to either aid comparison or lend it some legitimacy.

In the budget estimates for 2010-11, the Centre had made a provision of Rs
31,317 crore which has since ballooned to Rs 1,64,672 crore in the budget
estimates for 2012-13, a surge of over 425 per cent in just two years.

In the process, the "effective revenue deficit" has gone down to 1.8 per
cent of the GDP, giving Mukherjee bragging rights to claim that he has put
the country back on the road to fiscal consolidation.

But the truth is that the real revenue deficit still hovers at 3.4 per
cent of the GDP — at the same level as the budget estimates for 2011-12.

The finance minister has come up with some half-baked justification for
the change. "Focusing on this (the effective revenue deficit) will help in
reducing the consumptive component of revenue deficit and create space for
increased capital spending," Mukherjee said.

This argument is specious at best and flawed at its worst. Mukherjee
hasn't clearly spelt out how it will raise the headroom for capital
spending. The suspicion is that he will keep padding the grants' component
in order to keep lowering his actual deficit reduction targets.

The real reason for the change is clearly spelt out in the fine print of
Finance Bill 2012.

Under section 4 (1) of the FRBM Act, the government was supposed to
completely eliminate the revenue deficit by March 31, 2009.

Mukherjee is now amending this sub-section of the act to "eliminate the
effective revenue deficit by the 31st March, 2015, and thereafter build up
adequate effective revenue surplus and also to reach revenue deficit of
not more than 2 per cent of the gross domestic product by the 31st March

The 13th Finance Commission had clearly spelt out that the long-term and
permanent target for the Centre was to attain a zero revenue deficit.

The commission had said that this target was based on the golden rule that
"in the absence of economic emergencies, no economic agent should borrow
to finance current consumption."

Mukherjee clearly has different ideas about the deficit reduction targets.

The elaborate exercise means that the Centre has lost the moral high
ground to lecture states — especially Bengal, which was one of the last
to enact the FRBM Act — on the need to trim their deficits and tie them
up in knots by linking debt write-offs and disbursals of state-specific
grants to them based on their strict adherence to deficit reduction

Capital assets or revenue spending?
The sum being treated as
grants for creation of capital assets in the budget estimate for 2012-13
is Rs 164,672 crore. Two ministries — finance (Rs 51,597.75 crore) and
rural development (Rs 62,276.89 crore) — hog over 69 per cent of the
revenue spending that is masquerading as capital grants.

And what are the capital assets being created out of this corpus?
the Mahatma Gandhi National Rural Employment Guarantee Programme (Rs
31,659.59 crore), the Pradhan Mantri Gram Sadak Yojana (Rs 19,343.10
crore), the Indira Awaas Yojana (Rs 11,066.20 crore) — all under the
ministry of rural development.

Then there's the Accelerated Irrigation Benefits Programme (Rs 14,142
crore), the Backward Region Grants Fund (Rs 6,990 crore) and the
state-specific needs (Rs 6,723.75 crore) — all operated by the finance
ministry. Funds under these schemes were given to the Trinamool government
when Mamata was clamouring for a special package for Bengal.

Another big beneficiary of these grants is the Sarva Shiksha Abhiyan (Rs
8,409.06 crore) under the ministry of human resource development.

Reclassifying expenditures
Mukherjee’s plan to re-categorise
a portion of revenue expenditure as a grant for creation of capital assets
is an ingenious way to get out of a sticky situation.

During its elaborate discussions with the 13th Finance Commission headed
by former bureaucrat Vijay Kelkar, the government had tried similar
tactics without great success.

The committee, which submitted its report in December 2009, had slammed
the ploy. It said: "The existing classification of revenue and capital
expenditure cannot be disturbed in an ad hoc manner. It has to be the
result of a comprehensive study. Any disturbance of this classification
has wide-ranging implications for the finances of both the Union and the
states.... It is not possible to accept the suggestion... about
reclassifying some portions of revenue expenditure as capital expenditure.
It would thus be appropriate to continue with the existing classification
of expenditure as 'revenue' or 'capital'."

The government had argued that outputs constructed by the public sector
providing long-term benefits to society over time should be treated as
capital expenditures. Two areas where the re-classification was suggested
were health and education. So revenue expenditure on the National Rural
Health Mission or the Sarva Shiksha Abhiyan — two major social welfare
projects of the government — could be treated as capital expenditure, it
argued. The government had said that expenditure incurred on these
programmes was more akin to investment and, hence, it would be fair to
treat it as capital expenditure.

The 13th Finance Commission rejected these arguments.

Mukherjee has now come up with a halfway — house strategy: classify the
spending as a grant for the creation of capital assets and strip out the
spending from revenue expenditure to arrive at the effective revenue
deficit, which would then become the deficit to eliminate by March 2015.

This line of argument was never placed before the Finance Commission and,
given the vehemence with which it rejected the reclassification of revenue
expenditure as capital expenditure, it is doubtful that the commission
would have approved.

Delayed deadlines
Under the original terms of the FRBM Act
which was enacted in 2003, the Centre was supposed to completely eliminate
revenue deficit and cap fiscal deficit at 3 per cent of the GDP by March

But in 2004, the Centre first pushed back the deficit reduction targets by
a year to March 2009. It promised to bring down the revenue deficit by 0.5
per cent of the GDP every year from 2004-05. It also promised to pare the
fiscal deficit by 0.3 per cent of the GDP every year and bring it down to
3 per cent by March 2009.

In February 2005, then finance minister P Chidambaram hit the pause button
on the FRBM targets as a consequence of implementing the 12th Finance
Commission recommendations on higher fund transfers to the states. But he
was able to cap the fiscal deficit at 4.1 per cent the next year and later
assert that he had "redeemed my promise that the process of fiscal
correction will be resumed in 2006-07."

The global economic crisis in 2008 once again forced the government to put
a freeze on its deficit reduction commitments as it cobbled a Rs
186,000-crore fiscal stimulus package in the form of tax reliefs and
increased expenditure on public projects.

Revenue deficits first hove into view in the early eighties when the
government started spending more than it earned in the form of taxes.

"It was in 1979-80 that the central finances fell into a revenue deficit
after recording a surplus since 1950-51 in all but two years," says the
12th Finance Commission report for 2005-10. "The combined account of the
Centre and the states went into a revenue deficit in 1982-83 and that of
all states in 1986-87."

"It is vital that the revenue and fiscal deficit targets of the Act and
the Rules are not modified and the Centre sets an example for the states,"
the 12th Finance Commission said.

The International Monetary Fund, the Reserve Bank of India and the global
credit rating agencies have been urging the government to prepare a
credible roadmap for fiscal consolidation.

But it's obvious that the government has a different set of priorities.

- The Telegraph, Calcutta

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First Published: 19 Mar 2012 10:08 PM
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