To Spend or Not To Spend?


As Indians look forward to the budget, one of the biggest questions that confronts the government is whether it should increase spending. The dilemma does not pertain to this budget alone, but also the ones that will come in the future. Any call will have serious implications. None of the options are without cost. Debt plays a very important role in helping governments spend. It enables us to make productive investments, which help the economy grow.

Reckless spending and debt levels can cause major problems for the government and the economy. The government brought in fiscal reforms in the form of Fiscal Responsibility and Budget Management Act or the FRMB in 2003. Various state governments have also adopted this act to ensure fiscal discipline in states. The act specifies a target of 3% on fiscal deficit and to wipe of revenue deficits.

One of the biggest questions facing the government is whether it should have specific targets and ceilings on government deficit and debt levels. In India, the government plays a critical role in pushing the economy forward by way of its expenditure. Such a fixed number limits the ability of the government to be able to do so. There are numerous things that the government must spend on such as employment, health, education, research, infrastructure, defense, among others. It is difficult to prioritize and spend. Sticking to the limit would require us to sacrifice expenditure at some critical place. But when government starts spending without limits, there are problems such as increase in public debt, inflation and other macro variables which in turn affect the economy such as increased borrowing costs etc. There is also the problem of increasing debt, which would have to be repaid by the future generation.

In May 2016, the government formed a committee to review the working of the FRBM Act over last 12 years and shed light on this issue and to suggest the way forward in improving budgetary and fiscal issues. Former Revenue and Expenditure Secretary, N.K. Singh was appointed as the Chairman of this five committee which has eminent people such as RBI Governor Urjit Patel, Chief Economic Advisor Arvind Subramanian among others.

The committee submitted its four-volume report earlier this year in January. The four volumes deal with a wide range of issues such as the fiscal roadmap, fiscal policy, international experience and recommendations, Centre-State issues, etc.

In its recommendations, the committee suggested the following:

  1. Considering debt to GDP ratio as a medium-term anchor guiding fiscal policy and bringing down the debt levels to 60 per cent (40 for the centre and 20 percent for states) from the current level of 70.4 per cent (49.4 for centre and 21 for state).
  2. Reducing the fiscal deficit from 3.5 percent to 2.5 percent by 2023 in order to ensure debt levels are also maintained.
  3. Fiscal consolidation at state level as well to ensure the debt targets are reached.
  4. The government must reduce the revenue deficit by 0.25 percent of gdp each year to reach a target 0.8 percent by 2023 and not finance revenue deficits by debt.
  5. The escape clause calls for a 0.5 per cent bandwidth to meet emergencies as well as counter cyclical covers in fiscal policy.
  6. Ensuring a sync between fiscal and monetary policy to ensure effectiveness in achieving objectives of macroeconomic stability and growth.

What do these recommendations mean?

Revenue deficits is the difference between the revenue expenditure and the revenue receipts of the government. It is a situation where there is an excess of expenditure of revenue over the revenue receipts: the government’s revenue is less than the cost of maintaining the government’s machinery for day today activity. The committee recommends that the government reduce this deficit and not finance this deficit by debt. Revenue deficits should ideally not exist as it points to inefficiencies in the system.

The reduction in fiscal deficit and debt levels will require the government to systematically reduce its expenditure and debt. The impact of this would be the possible reduction in borrowing costs as sovereign ratings go up. This will also have an impact on the borrowing cost of individual economic agents such as firms looking at borrowing from abroad. However, this decision will have an impact on growth as government expenditure is considered one of the main drivers. Apart from the feasibility, the political cost of such a move could be huge.

These recommendations were to come into force starting April 2018. The government recently put this decision off.

Structural reforms will have an impact on revenues as well as expenditures. The implementation of GST will impact the revenue position of the government, while on the other hand, the government may have to increase expenditure to increase growth and counter and slow down caused by GST in certain pockets. While the government has put this off for now, it cannot  continue indefinitely without another series of budgetary reforms– There will come a time when the government will have to take a stand and pick.

-Contributed by Bhargav Dhakappa

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