raja swamy's List: Center Finance

• The FRBM Act is apparently well-intentioned, designed   to clean up public finances and put them on a sustainable   footing. Thus, it requires the reduction of the fiscal   deficit and the elimination of the revenue deficit   of the Central Government by 31 March 2008 (the deadline   is to be extended by a year). This would appear to   be a way of forcing the government to adhere to a   discipline which would thereby allow it to spend more   on useful capital expenditure.
   
    However, the actual implications of the working of   the Act are much more serious and potentially adverse,   than is generally understood. The Act requires the   Central Government to reduce the fiscal deficit by   0.3 per cent of GDP each year, and the revenue deficit   by 0.5 per cent each year, beginning with this financial   year. If this is not achieved through higher tax revenues,   the necessary adjustment has to be made by cutting   expenditures.
   
    Further, the Act prohibits the Central Government   from borrowing from the Reserve Bank of India (that   is deficit financing, involving the printing of money)   to meet its deficit, except for temporary cash advances.   This effectively rules out a cheap source of borrowing   and forces the government to borrow at much higher   rates, for no evident reason.
  

• The notification spells this out even more clearly:   ''In case the outcome of the quarterly review of trend   in receipts and expenditure…at the end of any financial   year… shows that

   
   
   
  1. The   total non-debt receipts are less than 40 per cent   pf the Budget Estimates for that year; or
   
  2. The   fiscal deficit is higher than 45 per cent of the Budget   Estimates for that year; or
   
  3. The   revenue deficit is higher than 45 per cent of the   Budget Estimates for that year,
• hen…   the Central Government shall take appropriate corrective   measures.''

1 more annotation...

• he   modus operandi of imposing expenditure cuts on the government   is through legislation such as the Fiscal Responsibility   and Budgetary Management Act, which had been passed   under the NDA government, and which the UPA government   promptly owned upon assuming office, even though the   Act constitutes an extraordinarily irrational piece   of legislation. The Act provides for a reduction, in   a manner stipulated by itself, in the magnitude of the   fiscal deficit to a ceiling of 3 percent of GDP. When   there is no legislation stipulating the minimum tax-GDP   ratio, when there is no legislation stipulating the   minimum ratio of social sector expenditure to GDP, when   there is no legislation stipulating the minimum expenditure   on anti-poverty programmes to GDP, why there should   be a law that stipulates the maximum ratio of fiscal   deficit to GDP is baffling to start with, when there   is absolutely no theoretical reason to believe that   a fiscal deficit is necessarily harmful. Matters become   even more bizarre when it is recalled that this ratio   is supposed to hold good under all circumstances, whether   there is a recession or not, whether there is a collapse   of employment or not, whether there is massive poverty   or not. And the bizarreness only increases when it is   recalled that a rise in the fiscal deficit does not   necessarily mean a rise in the government"s net   borrowing.
  
• onsider a simple example. Suppose the government borrows   from the banking system Rs.100 to spend on an employment   generation programme. Let us also assume for simplicity   that the only commodity for which demand is generated   through the expenditure on such a programme is foodgrains.   If there are plenty of foodgrain stocks in the economy   rotting in the godowns even as people go hungry owing   to lack of purchasing power, then it would be plain   stupid, indeed criminal, on the part of the government,   not to undertake this expenditure because the fiscal   deficit would increase thereby. But the stupidity in   such a case is even greater than appears at first sight.   The Rs.100 spent on the programme would accrue back   to the FCI which holds the foodgrain stocks, which itself   is a government-owned entity. The FCI may use the money   to repay its bank loans by Rs.100. In this case what   the government"s right hand (i.e. the budget) has   borrowed from banks is paid by its left hand (the FCI),   with no increase in the government"s net indebtedness   to banks. Indeed if FCI transactions figured as part   of the budget, as they used to do till the early seventies,   then the fiscal deficit in the budget itself would have   shown no increase. But the mere convention of not showing   FCI transactions in the budget would mean that government   expenditure on such an employment
• programme through   borrowing from the banks would be disallowed under the   FRBM Act. This Act therefore prevents the government   from increasing demand in the economy, including demand   in the public sector even when this sector is saddled   with unutilized capacity and unemployment. It ensures   both an eschewing of State activism for undertaking   investment, and providing employment and relief (and   hence an unrolling of red carpet for MNCs to undertake   investment in lieu of the State, even through offers   of guaranteed rates of return in foreign exchange),   and the perpetuation of "sickness" in the   public sector units which then is used as an excuse   to "privatize" them for a song. Professor   Joan Robinson, one of the outstanding progressive economists   of the twentieth century, called this self-serving argument   of finance capital against fiscal deficits the "humbug   of finance". The UPA is officially as committed   to this "humbug" as the NDA was, though under   the force of the circumstances it has both postponed   the target date for reaching the ceilings specified   under the FRBM Act, and used several subterfuges to   get around its stringency, as we shall see later in   the context of the 2005-06 budget.

1 more annotation...