Fiscal slippage: It’s not just about this year, junking revenue deficit target is worrying

Tucked away in the Medium Term Fiscal Policy (MTFP) Statement of Budget 2018 is a line that can be a bit worrying for the future of government finances. It says that in the proposed new fiscal responsibility architecture (based on the recommendations of the N K Singh Fiscal Reform and Budget Management committee), the government will target debt and fiscal deficit, “with fiscal deficit as an operational target and do away with the deficit targets on revenue account. . .” (emphasis added).

Why is this worrying?

In the rather polarised debate on fiscal consolidation in the run-up to the Budget, those leaning towards some fiscal easing waved a well-worn exception clause - the quality of the deficit. What it means is this: If the fiscal deficit is caused by greater capital expenditure rather than revenue expenditure, that it is worthy of being condoned. Because capital expenditure, after all, creates durable assets while revenue expenditure goes more towards consumption and other current expenditure. So, it is argued, the focus should be on reducing the revenue deficit, which will leave more money for capital expenditure.

But if revenue deficit targets are going to be done away with, then it becomes easier for the government (present and future) to stray from the straight and narrow path. It appears to be already happening.

Take the case of the 0.3 percentage breach in the fiscal deficit in the current fiscal (3.5 percent of GDP against the budgeted 3.2 percent). The MTFP Statement and the Fiscal Policy Strategy Statement that are part of the Budget documents attribute this to two reasons.

One, the fact that the government got revenues for only 11 months while undertaking expenditure for 12 months. Since the last date for filing GST returns for a given month is the 20th of the following month, the government will not get revenues for March 2018 (this is a one-time issue and the 12-month cycle will resume after that). Two, there was a 18 percent shortfall over Budget Estimates (BE) in non-tax revenues especially on account of deferment of spectrum auction and lower dividends from public sector undertakings and the Reserve Bank of India.

Image courtesy: Reuters

Image courtesy: Reuters

However, this is not just a revenue-expenditure mismatch issue; the skew in expenditure itself is problematic.

Capital expenditure in the current fiscal declined 11 percent over BE, while revenue expenditure increased 5.8 percent. This would have been frowned upon even if the government had stuck to the budgeted fiscal deficit; it becomes unacceptable in the case of a breach.

Importantly, the trend continues. In 2018-19, budgeted growth in capital expenditure at 9.8 percent is slightly lower than that of revenue expenditure which is set to grow 10.1 percent. The difference may be marginal right now, but how the next fiscal will pan out remains to be seen – crude prices are hardening and an election year can see populist pressures. The fact that the Budget has refrained from irresponsible populism does not mean restraint through the year.

This is a pity because the one thing that this government certainly deserves credit for is improving the quality of expenditure. Since 2008, the share of capital expenditure in total expenditure had remained in the 10-12 percent range (dropping to 8 percent in 2013-14). In both 2015-16 and 2016-17, the share had increased to 14 percent.

Simultaneously, there was a reversal in growth trends in the two heads of expenditure. Growth in capital expenditure had started outpacing growth in revenue expenditure, when it had always been the other way around. With the expenditure trends in the current and next fiscal biased towards revenue expenditure, it seems the government is going back to the old ways.

This is happening despite clear revenue deficit reduction targets. Now if even these targets are going to be done away with, there is unlikely to be any attention at all paid to the quality of expenditure and, hence, deficit.

The two fiscal policy statements argue that an excessive focus on cutting revenue expenditure can be problematic for two reasons.

One, some grants from the central government account, which are booked as revenue expenditure, are used for capital expenditure by those to whom these grants are given. Now this was the same reason Pranab Mukherjee gave when he brought in the concept of effective revenue deficit (which netted out such grants from the revenue deficit). He was widely slammed for what was seen as accounting jugglery. It’s a pity that Jaitley is using the same argument.

Two, the fiscal policy statements argue that not all revenue expenditure is non-essential, citing the case of salaries of teachers, medical personnel, cost of maintenance of capital assets or even medical expenditure on drugs, vaccines etc. But this was the same argument that was used when expenditure used to be classified as plan and non-plan – that not all non-plan expenditure was bad. In fact, this was deployed to bolster the argument for shifting from the plan-non plan classification to revenue-capital classification.

Nonetheless, the finance ministry has a point – an excessive focus on revenue expenditure could see a cutback in allocations for current expenditure in essential services. But is doing away with revenue deficit targets the answer?

When there is a deficit target that has to be adhered to, there will be a focussed effort to do something about it. In the case of revenue deficit, step up efforts to raise revenue and take a good, hard look at the quality of revenue expenditure and improve it - do something on the subsidy front, manage debt better to bring down the interest costs.

But if the deficit target is junked completely, will there be a close monitoring of the quality of expenditure at all? Even if the current government is more prudent, there is no guarantee that future governments will. This is what is worrying.

The writer tweets @soorpanakha

Updated Date: Feb 02, 2018 09:26 AM

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