The Telegraph
Since 1st March, 1999
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- The Centre’s fiscal health is the main constraint on growth

The author is an economist at the Indian Statistical Institute, New Delhi

“Centre rushes fiscal sops for states”, declares a headline in one of the financial dailies. The accompanying article describes the various measures that the Central government is contemplating to appease the states so as to ensure a smooth passage of the tenth plan by the National Development Council, a body which includes all the state chief ministers. These include an increase in the ways and means advance of the Reserve Bank of India to the different states, an agreement “in principle” to compensate states for the losses suffered by them on account of the introduction of value-added tax, and a debt swap package which involves retiring a large volume of high-cost debt incurred by the states.

The National Development Council has now adopted the tenth plan — the additional transfers (or more correctly promises of transfers) to the states will simply decide how much steam is let off by the states, which are always complaining about the unjust treatment meted out by the Centre. There is certainly some truth in the allegations levied against the Centre. The specific rules governing the powers of taxation of the states and the Centre imply that the Central government has control over the more lucrative taxes. This, in turn, means that the states are dependent on the grants received from the Central government, and the ruling party at the Centre typically exploits this power to further its own political goals.

However, how the total volume of public resources is distributed between the Centre and the states is perhaps of secondary importance in determining how successful the tenth plan will be in the next five years. What is of primary importance is the size of the overall volume of investible resources at the command of the Centre and the states. Unfortunately, that is pitifully small. All tiers of government in India — the Central and state governments — are either bankrupt or very close to it. Perhaps, the Central government is somewhat better off, but largely because it can ask the RBI to finance its deficits by printing additional rupees.

This is a radically different scenario from that prevailing roughly 30 years ago. During those days, several governments, both at the Centre as well as in the states, actually had surpluses in their revenue budgets. The revenue surpluses enabled governments to finance at least modest levels of development expenditure without running unduly large overall deficits. The health of the exchequer started deteriorating in the Eighties when governments started running deficits even in their revenue budgets. In the early Eighties, the revenue deficit of the Central government was still modest, being slightly over one per cent of gross domestic product. This figure has climbed steadily and has now crossed 4 per cent of GDP. The revenue and expenditure pattern in the states exhibited a similar pattern. Expenditures rose steeply while receipts stagnated.

There is no doubt that the Central and state governments have been sinking deeper and deeper into the mire. The state and Central governments have to share the blame for this depressing state of affairs in equal measure. With the exception of the Nara- simha Rao government — and that too in the first couple of years only — no government has shown the slightest inclination to take steps to stem the rot. Manmohan Singh, the finance minister in the Narasimha Rao government, did make desperate efforts to control expenditure. But, political compulsions proved too strong for him to continue with his belt-tightening measures, and populism prevailed.

The recent mid-term review of the economy also acknowledges that the fiscal health of the government is the main factor constraining growth. Jaswant Singh has also, on more than one occasion, voiced the same opinion. So, everyone has a right to ask why the government has not done anything to reverse the trend of rising expenditures and stagnant revenues. Of course, the failure to take appropriate action cannot be due to a lack of knowledge of what should be done because the main “culprits” are easily identified.

Government revenues have not been increasing sufficiently rapidly. Both tax and non-tax revenues have not kept pace with the growth of GDP. State tax revenues show a remarkably similar pattern. A major reason for the lower buoyancy of Central tax revenues has been the significant change in the composition of GDP. The services sector has become increasingly important. Unfortunately, this sector is relatively lightly taxed. The overall preference for dismantling tariff barriers along with policy-induced constraints on the expansion of imports have also meant that revenues from customs duties have not increased at a very rapid rate.

Much has been written about the need to supplement tax revenues by generating adequate non-tax revenues from public sector enterprises. Unfortunately, public sector enterprises continue to function inefficiently. And here, the record of state governments is even worse than that of the different Central governments. Given their failure to generate adequate returns on the vast amounts of capital employed in these enterprises, the only sensible solution would be to expedite the disinvestment exercise. This would have had at least two beneficial effects.

First, the proceeds from the sale of these enterprises could be utilized by the government for investment. Second, if the private sector indeed runs these enterprises more efficiently, then the resultant profits would be an additional source of private savings. But, as everyone knows, the entire disinvestment schedule has been upset because of opposition from some of our political masters.

Governments must also curb all non-developmental expenditures. Government expenditures have shot up after the last pay commission awards. Despite the increase in government salaries, it was entirely possible for the government to contain the outflow on salaries by simply reducing the size of its work force.

Now that there are fewer government controls on economic activities, there is surely a potential for effecting large cuts in employees involved in regulatory activities. Moreover, no drastic measure such as actual retrenchment was necessary. The government could simply have taken advantage of the regular attrition due to retirements.

The other area where the government needs to tighten up is in the subsidies given under various heads. Many of these subsidies — the best example being the food subsidy under the public distribution system — are very poorly targeted. The lack of proper targeting means that the welfare justification for maintaining these subsidies no longer exists. Unfortunately, vested interests have always ruled the roost in India, and these interests have always opposed any change in the status quo.

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