How will fiscal policy look in the near future? Remember, post-1991, when deficits were reduced, that was through buoyant tax revenue (courtesy growth) or slashing of capital expenditure. However, there was some consensus that deficits were bad and that tax reform was good. The former led to Fiscal Responsibility and Budget Management (FRBM) Act and rules, with state legislation following the Central one. Some teeth having been knocked out of the original draft legislation, there were only terminal year (2009-10) targets of 3% for fiscal deficit (share of GDP) and 0% for revenue deficit. Of course, there shouldn’t be fetish about fiscal deficits. But Indian government expenditure is largely for current purposes and no productive assets are created, which is why the revenue deficit is important. Even before the global financial crisis, the government was set to miss deficit reduction targets, thanks to flagship programmes, debt waiver, employment guarantee and Pay Commission. To that one should add off-budget items like oil and fertiliser bonds. That is, this isn’t classic expansionary fiscal policy through public expenditure on physical and social infrastructure. These included, the Centre’s deficit should be around 8.5% of GDP.
With states’ deficit contribution being 2.5% of GDP, overall deficit is 11%, back to pre-1991 levels. This raises three reasons for concern. First, whether or not high public borrowings and a lowering of interest rates can happen at the same time. Second, with slowdown, expansionary fiscal policy receives approval and the consensus on fiscal rectitude disappears. Unable to meet terminal year targets, any incoming government will relax FRBM. Third, this removes moral obligation on states to reform. If this reform consensus disappears, so may the other one on tax reform. As set out in the three Kelkar reports, this involves standardisation and removal of exemptions, concessions and discretions, without which compliance costs can’t be reduced either. The UPA goverment hasn’t distinguished itself on this agenda. And this too receives a stimulus, because downturn supposedly warrants reductions in rates, even if such cuts (direct or indirect) have doubtful expansionary impact. Inevitably, the GST (goods and service tax) agenda, due from 2010, gets postponed and concessions continue for IT, SEZs, backward states and whatever else one thinks fit. The entire fiscal reform agenda can be pushed back. Politicians should be mindful.