Tuesday, October 30, 2012

Handling Fiscal Deficit in India



On Oct 29 the Indian government Monday outlined a five-year fiscal consolidation plan that aims to nearly halve the deficit by 2017 and cut it to 5.3 percent (slipping from the targeted 5.1%) of the gross domestic product in the current financial year. The fiscal deficit had risen to 5.8 percent of GDP at the end of the financial year 2011-12. Higher spending on fuel, food and fertilizer subsidies along with sluggish tax revenues has led many economists to forecast a fiscal deficit this current fiscal year of about 6 percent of GDP. As per the plan outlined by the finance minister, the government's fiscal deficit would come down to 4.8 percent in 2013-14, 4.2 percent in 2014-15, 3.6 percent in 2015-16 and three percent in 2016-17. However, the government did not specify the measures that would help reduce fiscal deficit consistently. 

The International Monetary Fund this month slashed its economic growth forecast for India for 2012 to 4.9 percent from 6.1 percent previously. Rating agency Standard & Poor's said the country faces a one-in-three chance of a credit rating downgrade to junk over the next two years.

The government assigns several reasons for the fiscal stress including the slowdown in the world economy, lower growth in India, higher inflation, lower tax receipts and increased expenditure, including subsidies. The government feels that if it does not rein in expenditure at this point the economy may go into a cycle of low growth, high inflation and high deficit. The government feels that as fiscal consolidation takes place and investors' confidence increases, it is expected that the economy will return to the path of high investment, higher growth, lower inflation and long-term sustainability. The Kelkar committee has recommended rationalization of schemes and strict control and monitoring of expenditure. The process to contain the deficit will include the usage of unique identity number - Aadhaar - to distribute subsidies to the below poverty line population, thereby plugging leakages.

At this point I only fear that the government might go into an overdrive of reforms. It is attempting to manage the subsidy burden better by using an Aadhaar based system. The Public Distribution System (PDS) and fertilizer subsidies seem to be prime candidates for the effort. I feel that these are steps in the right direction and leakages of subsidies should be curbed. These are in any case low hanging fruits. Greater effort would be needed in better directing subsidies, a task at which most government s have balked. The capture of subsidies directed at the poorest of the poor by the well-off sections is omnipresent and all-pervading in most subsidies. 

I would like to illustrate my point with the example of the Aadhaar based delivery of essential food commodities. The Aadhaar ensures that ghost cardholders do not draw their rations and this is in itself no mean achievement. The District officials of the East Godavari district have stated that in their district wide pilot implementation they have realized savings of more than 30% in the commodities being distributed. The government has the difficult task of repeating this in all the districts of the country. This is a tall order in view of the differing levels of education and development across districts and ability to absorb the technology.

The government hasn’t still sunk its teeth into the more difficult task of better directing its subsidies and ensuring that they reach the poorest of the poor. In the state of Andhra Pradesh there has been a proliferation of ‘white ration cards’ with an intention to corner several subsidies which are directed at the poorest of the poor. Governments have political sensitivities which make this task all the more difficult. In fact, such tasks have proved to be very difficult all over the world. However, without addressing these basic issues, the structure on which our growth is built would be weak. I feel that we need to be the master of where we decide to spend our money and we should not look the other way when resources are drawn away against our collective will.

I would only like to point out that that the social services net in India is still very weak and has large holes to be filled up. Under the circumstances across the board cuts might hurt our society more than any benefit that would accrue. I only hope that the manager involved in the task would ensure that we don’t weaken our social services net any more than it already is.

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