The knife-edge balanced nature of Government finances means that there is little leeway available for the Central and State Governments whenever there is a shortfall in receipts or an increase in expenditure. In both cases, they automatically reflect in a substantial change in the fiscal deficit. As India moves towards a US$5 trillion GDP economy, the current slowdown and the longer-term runway offers two ways to recast the current fiscal architecture.
For the time being, we can park the debate on whether it makes more sense for the governments to run a counter-cyclical fiscal policy (i.e. pump in more money in the economy in times of slowdown even if it busts the fiscal deficit commitments) or keep true to its commitment on fiscal deficit numbers (irrespective of any slowdown in collections or in the economy). We take it is as a given that commitment to the fiscal deficit number matters more, especially since this is a number tracked closely by investors, credit rating agencies and the bond market which prices the cost of money.
The Short-term Fix: Massive Disinvestment
There are two key ways in which the fiscal deficit can be contained: (1) increase in revenues or (2) reduction in expenditure. As the expenditure is broadly committed and, in many cases, it may be politically very difficult to cut. There are efficiency gains that are possible: these require long-term initiatives (more market-linked prices, lesser permanent staff, discussions on pension strategy, finding sources of lower-cost debt, etc.) to be put in place to make these expenditures relatively more efficient as a percentage of GDP.
Increase in revenues can be driven in two ways. The commentary on high tax targets are creating some fear in the minds of businessmen, investors and citizens on whether the taxmen will have to be tough with them to meet his/her targets. Increasing the tax base, generating compliance, and going after those who plan their taxes (as opposed to avoid or evade) can be one way in which the revenue challenge can be met. The Government should use this situation as an opportunity by indicating that it is keen on pursuing another manner in which its revenue requirements can be met: large-scale disinvestments of its holdings in land and companies.
The Government has been making strong suggestions that it is committed to the disinvestment of Air India. Many more such public sector undertakings, especially those that are loss-making, should be immediately put on the block. Similarly, large shareholdings of the government or its PSUs in private entities (say the stakes in the various joint-venture airports or in some banks, etc.) can be relatively quickly be monetized. Large land parcels, if put on the block, can open up space for the government to develop newer industrial areas or expand cities. Asset monetization strategies in infrastructure sector (like roads, airports, ports, etc.) need to be pursued with vigor.
A disinvestment spree will demonstrate the Government’s commitment not just to its fiscal targets, it will bring about a new avenue for the private sector (and even foreigners) to bring in and invest capital. It will also signal a commitment to a belief in market forces, especially in the case of products and services that are clearly not ‘public goods’.
Running a large disinvestment drive is not easy. It is fraught with the challenges of eventual reviews by oversight agencies if the terms and prices are found to be compromised. The current challenge of job security or tenancy security needs an effective political commitment and resolution. However, it is possible if a Disinvestment Ministry is again put in place – with a possible explicit commitment that the monies that will come from such a ministry will be used for defense or capital investment. A well-run disinvestment program could create assets in private hands that become much larger sources of tax revenue for the Government instead of being a sink of money for financing every year.
The Long-term Solution: Redesign the Expenditure
With the goal of a US$5 trillion economy (or Rs 400 trillion, assuming an exchange rate of Rs80/US$), the Indian economy will double from its current Rs 200 trillion a year GDP size. We noted that both Central and State Governments put together account for around 25% of the GDP currently. Assuming the role of the Government in the GDP increases to 30%, this will imply that the total expenditure budget of the Governments will rise to Rs 120 trillion, from the Rs 50 trillion currently. The assumption of the Government increasing its share in the GDP is largely in line with the larger share of the Governments in the developed countries: the OECD average is close to 35%.
The more than doubling of the budgets of the government over a short period of time allows the luxury of the redesigning the system where there is more flexibility in the fiscal architecture. The design of both the revenues and the expenditures of the Governments requires a radical rethink – both in absolute and in relative numbers.
A long-range planning which sets the broad direction over the next five years or so can allow for a significant redesign of the fiscal architecture and the policies accompanying it. This will not only provide policy clarity to the tax payers, it will also offer a roadmap to the various projects on the amount of available funding. The report of the Fifteenth Finance Commission will give a reasonable starting estimate of the funds that might be available over the next five years. Building on that base to redesign the expenditure pattern of the Central and State Governments can build in more long-term flexibility.