Time to do away with fiscal responsibility law?
No virtue in stipulating 3%

The time may have come to bid goodbye to the law on fiscal responsibility, because it is doing more harm than good. No deficit target set under the law has been met in any year, except perhaps once in 2007-08. Target years for reaching the desired fiscal deficit (3 per cent of gross domestic product) have been pushed back constantly, or “paused”. The compounding problem is that, when finance ministers have been unable to get even close to the targets, they have fudged the books and pushed the fiscal burden on to hapless public-sector entities, whose treasuries have been raided in more ways than one in the effort to close the reported gap in the government’s numbers. One result is that oil companies that were once cash-rich are left with little cash of their own to invest.

T N Ninan, Business Standard
10th October

Other tactics to show adherence to targets under the fiscal responsibility law have included not paying bills (note the minister’s recent instruction that overdue payments to small and medium enterprises should be made immediately — which implicitly leaves out the rest though their money is also overdue). Alternatively, tax officials, under pressure to deliver revenue numbers, have coerced companies into paying up excess tax in the closing month of the year, on the promise of a refund early in the next year. And yet, despite such tactics, the deficit numbers have remained stubbornly out of line. Anyone in doubt about the real picture should read what the Comptroller and Auditor General told the Finance Commission: that the Central deficit was not 3.46 per cent in 2017-18 as Parliament has been told, but a much higher 5.85 per cent.

Why do we make finance ministers go into such contortions, to tell us that near-6 per cent is 3.5 per cent? Why not encourage more open and full accounting so that the country knows the real picture? Under-reporting the real deficit encourages key people in governments to believe that they can afford to spend more, when in reality they don’t have that cushion. Correctly reported numbers, with their warning lights flashing, would (hopefully) encourage a greater sense of fiscal responsibility. If nothing else, private-sector economists, rating agencies and the like who today parrot the government’s version of the deficit, would tune into a very different reality — and build market pressure for fiscal correction.

Dispensing with the fiscal responsibility law by itself is not enough, for fudging went on even before such a law existed. Scrapping the law has to be combined with other changes to make fudging difficult. One is to move away from the current, archaic system of cash accounting that most countries have given up. Cash accounting leaves out of the books the expenditure that the government has undertaken but not yet paid for (e.g. payments to infrastructure companies for work done on roads, bridges and the like). Most companies account in their books for the money owed to creditors; the government does not, and gets away with it by following the cash-accounting method. The other, complementary step would be to provide a fuller account of public-sector borrowings. This would bring into the open the expenditure that the government currently pushes on to entities it owns — like the Food Corporation, which has borrowed from small-savings funds to pay for the food subsidy that should have been funded through the Budget.

Even if these changes don’t deliver credible budgeting, there is no great virtue in stipulating that 3 per cent is the desired level of fiscal deficit at the Centre. As TCA Srinivasa-Raghavan has argued more than once, that number was simply copied from the European figure, although the economic context for India is radically different from that in Europe. It is entirely plausible, for instance, that the Indian system with its faster economic growth rate can cope quite well on all the usual macro-economic indicators with a higher deficit — even if not one that is quite as high as what exists now. Such questions cannot begin to get addressed in a world of real numbers till everyone knows the truth about the deficit.

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A few links for further reading

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