Jaitley's new team signals the end of Leftist economics, fiscal fiction

With the appointment of Arvind Subramanian as Chief Economic Advisor in the finance ministry and Rajiv Mehrishi as Economic Affairs Secretary, the economics team left behind by P Chidambaram is gradually being shown the door. Hopefully, it also means the dumping of Chidambaram’s dubious economics of deceitful account-keeping and future budgets that are dictated less by NGOs and jholawalas.

The fact that Chidambaram has welcomed the appointment of Subramanian is of little consequence, for the chances are Subramanian will promote policies that are the exact opposite of the financial skullduggery practiced by the previous finance ministry team. In fact, Subramanian was a big critic of Arun Jaitley’s first budget, and his criticism was precisely that Jaitley continued with Chidambaram’s fictitious fiscal numbers.

He wrote at that time: “It is widely accepted that there was a smoke-and-mirrors aspect to the numbers in the interim budget crafted by the previous government, which artificially reduced or deferred expenditures by up to 0.3 percent of GDP. The (Jaitley) budget should also have moved toward purging asset sales/privatisation receipts from the headline deficit number. Instead the budget continues these shortcomings.”

The other man in the finance ministry, Mehrishi, comes with a formidable reputation for reforms, having just heralded Vasundhara Raje’s labour and other reforms as Chief Secretary of Rajasthan. Add the reformist team at the Reserve Bank of India - Governor Raghuram Rajan and Deputy Governor Urjit Patel - and we have a fairly reform-minded quartet in North Block and Mint Street.

The only two members of Chidambaram’s finance team still in the ministry are Ratan Watal, expenditure secretary, whose seniority could mean he could be named finance secretary, and GS Sandhu, the financial services secretary. In Jaitley’s first budget presented on 10 July, the only new team member was revenue secretary Shaktikanta Das. In the next one, the majority in the five-member ministry team (which would include disinvestment secretary Aradhana Johri, appointed last month) will be NDA appointees.

The chances are the finance ministry team will attempt a more radical departure from the dole-and-subsidies economics of the UPA, even though some will remain there for political optics. But it is highly unlikely that even populism will be dictated by jholawala economics.

None of the top four economic policymakers in North Block and Mint Street presumably believes in Chidambaram’s sleight-of-hand economics. What this means is that in the next budget, Jaitley may well begin by stating the truth about the budget numbers. While it is not clear if all the numbers for 2013-14 (the UPA’s last budget) and 2014-15 will be restated in the 2015-16 budget, the appointment of Subramanian would make little sense if we do not even get a fairer picture of the centre’s finances.

None of the top policy-makers believes that India’s problems were created by the global slowdown alone - something Manmohan Singh and the UPA have been claiming to explain the economy’s poor performance over the last three years. Arvind Subramanian has said in the past that “a changing external environment, while significant in the short-run, should not be what keeps emerging market policymakers awake at night….the ultimate cause of macro-vulnerability is the high fiscal deficits, in turn caused by the fact that government spending per capita (intrinsic to redistribution through rights and entitlements) has increased 75 percent under this (UPA) government.)

He wrote that last year, and one presumes he has not changed his mind now.

The economic quartet at the finance ministry and the Reserve Bank is thus unlikely to give excuses for poor performance and is solid enough to attempt a relaunch of India’s growth story with the help of sounder economics.

A start clearly has to be made by cleaning up the government’s cooked up books. As I have repeatedly stated in the past, Chidambaram’s fiscal deficit figures of the past are pieces of fiction , attained by repeatedly bringing forward next year’s revenues (advance taxes, public sector dividends, etc), pushing back current year expenditures (subsidy payments) and cutting down on good expenditures (plan and capital spending). This has prolonged the slowdown for the meagre benefit of showing a lower fiscal deficit.

While Subramanian’s hand will be seen in the Economic Survey for 2014-15 that is presented before the budget in February, Mehrishi, Watal. Shaktikanta Das and Johri will be the key players behind the main budget. But one can be sure Subramanian’s voice will not be left unheard while it is being formulated.

So what kind of structural reforms should be the finance ministry team espouse in the budget-making process itself? If, as Subramanian suggests, the disinvestment receipts are to be taken out of the fiscal deficit number and shown separately, the budgeted fiscal deficit for 2014-15 (Rs 5,31,177 crore would rise close to Rs 6,00,000 crore. This would bloat the real fiscal deficit to 4.6 percent from the projected 4.1 percent.

But other misstatements will remain. For example, the subsidies on kerosene and LPG paid by the oil and gas companies are not shown as the government’s liabilities at all. Logically, all subsidies should be shown as government liabilities even if, by arrangement, they are paid by the public sector companies.

Here are some reform measures in budgets that are worth considering for the new team. These points are worth replugging even though I have written about them in the past.

First, the finance minister must shift to an accrual-based system of accounting. This means the budget will take into account revenues due during any given year (even if not received) and account for expenses incurred (but not yet paid out). This is what good companies do. This would give a true and fair picture of the real state of financial health of the Centre. Under Chidambaram, the ministry happily brought forward next year’s incomes and pushed back expenses from the current year to next year (oil and fertiliser subsidies, for example) to show a better fiscal balance. It is a piece of accounting fiction. The least a finance minister can do is present a clean set of books to the nation.

Second, the Centre should steadily shift to a system of zero-based budgeting (ZBB) for long-term schemes and projects financed by the taxpayer. What’s ZBB? Shorn of the technical jargon, ZBB is about asking yourself regularly if a half-finished project is worth finishing and wasting more money on. Let’s say a bridge was sanctioned in 2001 at a cost of Rs 100 crore. Today, after only a third of it is done, the sunk cost is Rs 500 crore and the total estimated cost is Rs 2,000 crore. The human instinct will be to say since we spent Rs 500 crore, might as well put the rest of the Rs 1,500 crore and finish it. But a ZBB guy will ask: since we are going to spend Rs 1,500 crore (or more) to finish the bridge, can we get better bang for the buck on another project with that kind of money? Or something better for a lower cost? A longer road diverted around the river, or whatever. ZBB is about pulling the plug on deadbeat projects and saving the money for something better.

Third, the FM should insist that every new spending proposal from any ministry should be accompanied by its own means of financing. For example, if the health ministry wants to implement a health insurance scheme for all citizens costing Rs 20,000 crore per annum, it should figure out how it can be financed. Maybe with a cess, or by creating a fund through NRI contributions, or whatever. This way we will at least know who is paying for it. Also, ask for alternatives: can direct cash transfers to identified beneficiaries work better? There is no need to run huge budget deficits to finance social spending. Also, spending ministries have the option of funding a part of the social spends through voluntary contributions, too. The job of government is to enable worthwhile social spending, not do all of it itself.

Fourth, every subsidy - whether for oil or fertiliser or food - should be directly coming from the budget. This will, of course, bloat the budget deficit in the short term, but it will at least be transparent. It will allow for realistic budgeting and make people conscious about costs and benefits. When ONGC subsidises your diesel and kerosene, everyone thinks these goodies have no cost. This needs to change. Specifically on oil subsidies, the NDA government needs to clearly move towards deregulation and end subsidies on all products except kerosene and LPG. In these products, the subsidies can initially be capped at a fixed sum - say Rs 400 per LPG cylinder, and kerosene, at Rs 20 a litre (current subsidy: Rs 33). Both should ultimately be brought down to zero. Those considered still too poor to afford household fuel should be given direct cash subsidies. The big advantage of a cash subsidy is that it does not distort the market for fuels and there is no incentive for adulteration.

Fifth, no public sector undertaking should be administered by any policy-making ministry directly. The job of a ministry is to make policy, not run companies. All government shareholdings should thus be transferred to a public trust owned by the president. The trustees should be public spirited persons of impeccable integrity. Their job should be to maximise value from these shareholdings for the taxpayer and the exchequer. Every government order that impinges on public sector profitability and autonomy should be routed through this trust. This way, the oil ministry cannot transfer profits from ONGC to Indian Oil, Praful Patel would not have been able to ruin Air India with his meddling, and Coal India would not have to foot the power sector’s subsidies. This is the reform that will face maximum political opposition: which child will let go of the lollipop? But if Subramanian wants disinvestment proceeds to be kept out of the budget, an even better idea is to keep the public sector out of ministerial meddling.

Sixth, as a corollary to item two (zero-base budgeting), the finance ministry must set up a well-staffed spending monitoring arm which not only figures out where the money has gone, but how well it is being spent. For example, the objective of every scheme should be to maximise benefits for the people it is intended, and reduce administrative costs and waste. If only Rs 5 out of every Rs 10 spent on the public distribution system goes to the poor, the monitoring arm should blow the whistle and start cutting allocations or fix the problem in a timeframe.

Seventh, the differentiation between plan and non-plan spending does not make any sense any more. What we need to know is whether we are spending money on creating assets (which is capital outlay) or in feeding people and administration (which is revenue outlay). Even schemes like NREGA should be implemented with the idea of creating assets - and not jobs through boondoggle projects. It is good that the scheme is being revamped, despite protests from a bunch of jholawalla economists.

Eighth, every tax break must state clearly who is likely to benefit from it (especially if the beneficiary is a company), and also the number of people it will benefit. Very often a concession is announced and we find that there are only one or two beneficiaries. Transparency is the key to new tax proposals. There is nothing wrong if a policy has only one beneficiary, but we need to know this and not find out about it after a scandal. The 2G scam would not have been a scam if the government had clearly stated that the purpose was to ensure cheap tariffs. Estimates of the systemic benefits of this “giveaway” could have been done to buttress the argument.

Ninth, elimination of subsidies need not necessarily begin with identifying the poor, but can start with the rich. For example, once the Aadhaar Unique ID is established, anyone earning more than Rs 3 lakh, according to his tax returns or through other ways of income estimation, should automatically be lopped off from receiving cheap LPG or kerosene or diesel. It is easier to identify the rich than the poor in India. Identifying the poor is a long-process, and can be taken up in stages. A scheme for voluntary exclusion from subsidies would also have a cathartic effect on trust and goodwill.

Tenth, the best way to ensure long-term fiscal consolidation would be to mandate that the expenditure growth rate must be 20-30 percent lower than revenue growth every year till fiscal consolidation is achieved (say, a fiscal deficit of 3 percent of GDP or less, and a revenue deficit of zero). Thus, if revenue is expected to grow at 15 percent next year, expenditure should be held down to 10-11 percent. And if this is not achieved, fresh taxes should be imposed or unproductive expenses cut.

Eleventh, in a dynamic economy, where the economic environment changes frequently, the budget cannot be a one-time event. Taxes, spending and policies have to be changed whenever objective conditions change - as we did in 2008-09 after the Lehman crisis. The finance minister is not an accountant, but the country’s economic risk manager (along with the Reserve Bank chief). A budget thus has to become a living document that is adjusted frequently to meet new challenges emerging from global and domestic events.

Hopefully, Jaitley’s new economics team is gung-ho about change.