The freebies issue has expectedly taken a political turn, but its main
essence is being missed. The choice of spending should ideally be with the
government, as priorities vary. The problem surfaces when the fiscal deficit
reaches high levels, which is not sustainable as debt levels rise.
Interestingly, before the pandemic, the level of state debt was around half
that of the Centre. Also, while the Centre never logged a fiscal deficit ratio
of less than 3% after 2007-08, all states combined had clocked less than 3%
after 2004-05 right up to 2020-21, barring 2015-16 and 16-17. Here too, it was
less than 3.5%.
Hence, there is a priori reason to believe that states have managed
their fiscal deficit ratios better. They have tended to be more constrained
because of the Fiscal Responsibility and Budget Management (FRBM) rules, which
cap the deficit at 3% of gross state domestic product. Breaching this level
requires special permission, which brings in internal discipline. The same does
not hold for the Centre, which has been advised but never compelled, given the
level of responsibility taken on.
If it is assumed that states and the Centre have the right to spend
money where they want, as any money given in the form of subsidy or cash
transfer ultimately benefits someone, a route needs to be devised to ensure
that the fiscal deficit is kept in check. At the end of the day, states should
not be borrowing more than they prudentially should, which is denoted by this
number. There are rules needed to cap the deficit as well as ensure
transparency. If this is done, then the quality of spending can be kept aside
for a separate debate.
First, we need a rule that is binding on both the Centre and states. The
Reserve Bank of India can be made the door-keeper to ensure that access to the
debt market closes beyond a prescribed level. This level can be fixed as
thought fit, but must be held sacrosanct. There is actually no basis for the 3%
mark (which was the standard for being part of the Eurozone during its monetary
union). The FRBM Act offers a path that is not enforceable and hence does not
help.
Second, we must include contingent liabilities as part of the fiscal
deficit—both of the Centre and states. This will deliver transparency and
ensure that debt doesn’t build up outside budgets. The Centre has already made
a serious correction by including Food Corporation of India borrowings in the
budget in 2020-21. The same should hold for states, so a true picture of debt
emerges.
Third, as a rule, guarantees by the government to any publicly-owned
entity should be banned. These tend to create a perverse incentive of not
taking responsibility for performance. Once removed, the entity will be forced
to operate on commercial terms. This will hold for power distribution companies
in particular. Once guarantees are gone, they will have to borrow money from
the financial system based on their strength and performance. They will no
longer be subsidized by a backstop. As a result, they would not be able to
provide free power and accumulate losses, which are presently funded by banks
and financial institutions. If free power has to be given, the state must pay
for it from its budget, which will be constrained by the deficit rule. This
will ensure discipline.
Fourth, if it is felt that capital expenditure is the job of the
government, then a certain portion of the borrowing should be earmarked by a
rule. This will ensure that the responsibility of the government in building
infrastructure is never compromised. Here, the apex authority, which should be
the Finance Commission, must strongly mandate the level of capex at, say, 20%
or 25%. This would lessen the space for cutting back on such expenditure
whenever a government opts for ‘freebies’.
These simple rules can make implementation easier. Governments can offer
free power or write off loans, but will have to pay from their budget. As such
measures are often taken to gain political mileage, the electorate can decide
whether a larger section is being left out of the development programme and
take a call accordingly at election time. If a government spends more on giving
free power to farmers and cuts spending on health and education, such an
establishment could be voted out.
The issue today is that there has been a tendency of proliferating
competitive announcements by all governments of so-called freebies that get
camouflaged by terminology. Any ‘incentive’ is acceptable while a ‘subsidy’ is
frowned upon. A corporate tax cut is applauded, while giving sewing machines is
not found acceptable. Funding banks with capital is a solution when banks run
dry due to provisioning for non-performing assets, but farm loan waivers are
seen to create a moral hazard. There are different sides to these arguments and
we may never find a satisfactory answer.
Hence, clipping the state’s wings at the final level of borrowing, as
reflected by its fiscal deficit, will address these issues, though it may take
time. This way, the onus of decisions remains on the government. The fiscal
deficit number becomes sacrosanct irrespective of funding from cash balances,
market borrowings or the National Small Savings Fund. The concept of freebies
can still be a subject for discussion, but will not really matter then.
No comments:
Post a Comment