Many economists including this writer have been advocating strict adherence to the path of fiscal consolidation. I am not a fiscal hawk but I join with the hawks in the Indian context. The FRBM target has been relaxed far too many times in India's recent history for any plausible explanation for another relaxation to carry any credibility in the domestic and international financial markets. Further, the ostensible reason for relaxing the FRBM target, to increase public investment, does not hold. For 35 years now, the central government borrows to consume, not to invest.
The rationale for this is just common sense glorified as what economists call the "golden rule". Consumption must not be financed through borrowing. It is for this simple reason that we discourage our children from borrowing money for an ice-cream but are willing to borrow to invest in a house.
Investment generates economic returns that ultimately allow the government to increase the size of its consumption expenditure. Borrowing for consumption does not do so and adds to the interest burden on the government. The golden rule means that the government consumption expenditure should be financed through taxation, unless there are rare and exceptional circumstances to deviate from this norm. Since the enactment of the FRBM legislation, the states as a whole (rich and poor; big and small) have been adhering to this rule.
With the Centre, this has not been the case since 1981; the FRBM legislation has not worked for the Centre. The revenue/fiscal deficit ratio has increased from 4.5 per cent in 1981-82 to 41.7 per cent in 1990-91, to 71.6 per cent in 2001-02, and to 71.8 per cent in 2015-16. So, consumption increasingly has been the driver of central government borrowing, and not investment.
The anatomy of this consumption is worthy of examination. Total revenue expenditure in FY13 was Rs 12,43,509 crore. Interest payments accounted for 25.2 per cent of total revenue expenditure. This (or at least 70 per cent of it) is a consequence of 35 years of borrowing to consume, a committed legacy. No finance minister can reduce this interest burden without running a significant fiscal surplus which is simply untenable for a developing economy. Some reduction in fiscal burden can occur if the interest rate on government debt falls but the government already borrows pre-emptively at a lower rate than others.
Subsidies accounted for Rs 2,57,071 crore in FY13 or 20.7 per cent of total revenue expenditure. Here, there is substantial room for expenditure reduction but the political economy of subsidies is a story that has oft been repeated and I shall not dwell on that here. Suffice to say that even a 50 per cent cut in subsidies in FY13 would have resulted in reduction of the revenue deficit by approximately 1.2 per cent of GDP, still leaving the government with a revenue deficit of 2.4 per cent of GDP. So this is not enough.
The third item of consumption is the pay and allowances provided to central government personnel. According to the 7th CPC report, total expenditure on them amounted to Rs 1,92,580 crore or 15.5 per cent of total revenue expenditure in FY13. By international standards, this is not large but given the notorious optics of bureaucrats idling in offices, could an axe be taken to this number?
Out of total pay and allowances expenditure, Rs 55,038 crore is spent on the railways. This amount is irrelevant for the revenue deficit since the railways has its own budget and is expected to cover its own expenditure from revenue generated (called the operating ratio). The ratio is close to 0.9 which implies it covers the railways covers its current expenditures from its own revenues. So is the remaining Rs 1,37,542 crore, the amount spent on bureaucrats in FY13? No. Our expenditure on defence personnel amounts to Rs 75,869 crore. Presumably, this is a sacred cow. There appears to be a national consensus that our soldiers, sailors and airmen cannot be dispensed with.
That leaves us with Rs 61,673 crore. From this we must also deduct the amount spent on paramilitary forces like BSF, CRPF, CISF and SSB. These forces have expanded hugely since the 1980s and have grown from 3.25 lakh in 1984 to 9.72 lakh personnel in 2014. This is the price we pay for a disturbed internal security situation whose causes are too profound to dwell on here. Nevertheless, the two pertinent takeaways are: (a) the causes of this explosion in the recruitment of police forces over 30 years are clearly structural and there is little fiscal room here to manoeuvre; (b) as law and order is the basic function of a government there are few shiftless bureaucrats to be sacked.
The anatomy of the revenue deficit points to an inexorable structural reality; the central government is borrowing to consume and the consequences of this have been structurally weakening its fiscal health over the past 35 years. High outgoes on interest on debt is the price we pay today. Cutting subsidies would help, but not solve, the problem. The expenditure on government personnel is directed at the most basic function that a state has to perform, i.e. law and order. So the reasons for poor and deteriorating fiscal health of the union government are structural in nature and not amenable to fiscal medicine alone. Hence, in the absence of structural reforms, there is no short-term option but to persist with fiscal consolidation.
