End of Neo-Colonialism

The babel around the Budget and the XIV Finance Commission and subsequent comments and analyses have now ebbed. There are some States and stakeholders who are critical based on inadequacies of allocation in the social sector. But there is a consensus that the Budget represents a credible balancing act and gives a decisive momentum to the economic upturn which has already commenced. Thomas Sowell has said “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” So which lesson did the Budget pursue?

In retrospect, there were some overarching policy options to leverage that the Finance Minister had.

One, the classic choice: growth versus inflation. How much of fiscal flexibility was acceptable to enhance public outlays in infrastructure – railways and highways? The budget has adhered to the path of fiscal rectitude by meeting the fiscal deficit target of 4.1% this year.  It has postponed the terminal fiscal deficit target of 3% by an additional year with somewhat higher intermediate targets. The rating agencies prefer a closer adherence to the fiscal roadmap.  Of course the new time path must be adhered. I have for long argued that parliamentary approvals must be ex-ante than ex-post. The recommendation for a Fiscal Council contained in the Finance Commission’s recommendations is sensible.  This along with the new Monetary Policy Framework Agreement between the Finance Ministry and the Reserve Bank of India would act in congruent ways. It will ensure harmony between monetary and fiscal policy and thus Mint Street and North Block.

Two, subsidy rationalisation. There are significant gains in rationalising petroleum and fertilizer subsidies by de-regulating petrol and diesel and moving over to the Aadhar based LPG subsidy.  Further action is needed on fertilizers, particularly Urea. There must be pari-passu progress as JAM (Jan Dhan-Aadhar-Mobile) gathers momentum.

Three, congenial external environment to be harnessed. Oil prices have dramatically declined from $82 to $59 with soft commodity prices. The current account deficit is acceptable even though in the long run sluggish export behavior needs innovative action beyond conducive exchange rates.  We could have used this opportunity to create greater fiscal space for the future. Public debt could have been retired or a Consolidated Sinking Fund for amortisation of debt created. The Finance Commission suggests this can “tide over, roll over risks and the weak cash management practices.”. A middle path has been preferred. Substantial benefit has been passed to the consumers enhancing their purchasing power, allowing oil companies to recoup some losses and raise revenues to meet fiscal targets. Given the opportunity, this must be pursued.

Four, the XIV Finance Commission’s recommendations. There is overwhelming precedence that on devolutions they have been treated as awards than recommendatory. Consequently, total devolution to the States is now 62% of which 42% is from common divisible pool of taxes. The rise in tax devolution to States and the Non Plan grants to local bodies together represent a sharp cut of ’206292 crore from the Centre’s resource block. In the shrunken resources for the Central government the funding pattern of schemes has under gone a structural shift.  The Budget at a Glance again highlights the middle path. It classifies public outlays in three categories – schemes to be supported by the Union,  schemes to be continued with change in sharing pattern and those fully de-linked from Central support. The major flagship programmes of the government remain in the Union list like the Sarva Shikaha Abhiyan, MGNREGA, Pradhan Mantri Gram Sadak Yojna. There are others which would be financed with a changed sharing pattern. Schemes de-linked from Central support, leaving it for the States to decide are rather small. The most contentious being the Backward Region Grant Fund to Bihar, KBK and Bundelkhand.

There has been misplaced criticism that social sector outlays have been drastically pruned.  In making such comparisons a methodological error has crept in.  Analysts have compared the Budget Estimates of 2014-15 with the Budget Estimates for the current year. Those familiar with public finance know that normally the comparison is between the RE (Revised Estimates) with BE (Budget Estimates). Such comparison would suggest that allocations have been kept more or less intact. In the case of Integrated Child Development Scheme (ICDS) the reduction is sharp, but the pattern of funding is yet to be decided.

Thus the Budget and the Finance Commission are two sides of the same coin. It emanates from the design and conception of a new financial architecture of Centre-State relations. It is a giant step in promoting federalism where much larger untied resources become available to the States for selecting, designing and implementing programmes best suited to their needs. The Government had little option given the shrunken envelope after accepting the Finance Commission’s recommendations.  After all you cannot have the cake and also eat it. States cannot have both the cake of large untied resources and eat the Centrally Sponsored Schemes as originally conceived.  One can argue of whether this was the best approach or could the recalibration have been somewhat different? 

Will this new model of Fiscal Federalism work? There are inherent risks but also existing opportunities for Team India. The risks are well known if the State Governments act irresponsibly or promote fiscal profligacy. But in the end, the Government at the Centre and the States are judged by the improvement and development of life quality by the Electorate whose periodic mandate they seek.

The new fiscal architecture eliminates the form of neo-colonialism like what Rudyard Kipling described as the White Man’s Burden  viz. the Centre knows what was good for the States. A new social compact between the Union and the states has been ushered.

Thus, the adoption of the XIV Finance Commission’s recommendations and the Budget reflect that the Government has accepted both, the first lesson of economics and the first lesson of politics. A credible balancing act is what the budget is all about.

बड़े आर्थिक बदलाव का मौका

Money-wise: A budget is as good as our implementation capabilities

It is said that no success is final, nor failure fatal — it is the courage to continue that counts.

The Delhi electoral outcome has rekindled a fresh debate on the preferred model of development. Apart from other factors some analysts argue that the economic policies of the government have a pro-rich bias and alienated a large voter base among migrants, slum-dwellers and, generally, the very poor. The forthcoming budget, they argue, must course correct. This reasoning is truly farfetched. The focus of the election campaign by AAP related to issues of corruption, safety of women, availability of drinking water and inadequacy of basic infrastructure. Critics overlook that the amendment to the Land Acquisition Act pertains to the ponderousness of the process and does not dilute the generous compensation. Similarly, with respect to the MGNREGA based on CAG report the emphasis rightly has been placed on capital-creating assets. The approach also overlooks the more basic fact that the excessively entitlement-driven policies of UPA 1 and UPA 2 weakened macro fundamentals, reduced investable surpluses and smothered investor confidence. These entitlement-driven rights embedded in several legislations were a major draft on shrinking resources. Coupled with weak delivery systems with inherent leakages they eluded improved life quality to intended beneficiaries. Any economic strategy must be designed to create more jobs, improve outcomes of social spending, quality of infrastructure and improve competitive viability to attract private investments.

All principles of distributive justice are predicated on enlarging the size of the cake. The reverse is a vicious quagmire of a low-level equilibrium trap.

For too long budget expectations remain misaligned with contemporary realities. Broadly speaking, in a comparatively closed economy prior to 1991, the budget was predominantly an accounting statement of projected revenues and intended expenditures. Post 1991, the budget increasingly becomes an occasion to go beyond accounting and articulate the broader economic and social agenda of the government. This approach in the earlier reform period of 1991 to 1994 was fostered by multilateral institutions as a pre-condition for access to their resources.

Speculation, uncertainty and excessive secrecy contribute to the mystique of the budget process. It is not adequately recognised that all over the world economic policy-making is a continuous process. The budget is hardly a panacea for either all economic malaise or response to multiple economic challenges. In an increasingly inter-dependent world we need to adopt the best international practice in the budgetary process. The OECD Best Practices for Budget Transparency report has suggested an ex-ante engagement than ex-post outcomes. It argues that ‘a pre-budget report serves to encourage debate on the budget aggregates and how they interact with the economy. As such, it also serves to create appropriate expectations for the budget itself.’ British economist John Maynard Keynes suggests “Successful investing is anticipating the anticipations of others.”

So what should we anticipate for the forthcoming budget?

First, continue the focus on growth, investments and employment creation. Distractions and plea for populist programmes must be subsumed as part of the broader priority agenda of the government, which focuses on externalities, public goods, enhancing our competitive viability and total factor productivity of the economy.

Second, both savings and the investment rates and investment gearing ratio need to substantially increase for transiting to a higher growth trajectory.

Third, reiterating the commitment to fiscal rectitude and the path of fiscal consolidation. Mechanical fixation of fiscal deficit should be replaced by cyclically adjusted fiscal deficit with latitude to reach end targets with flexibility during the intervening period. The concept of cyclically adjusted fiscal deficits now has wide acceptance. As Glenn Hubbard, dean of the Columbia University Graduate School of Business, reminds us, “Gradual fiscal consolidation may also be stimulative in the short run.”

Fourth, improved expenditure management, reduction in the number of centrally-sponsored schemes and given reported generous award of the finance commission coupled with subsidy rationalisation, particularly direct benefit transfer, benefit macro management.

Fifth, a reiteration of abstinence for future retrospective changes and acceptance of judicial or quasi judicial or arbitration outcomes improves investor confidence.

Sixth, lowering tax rates to improve opportunity cost of investment and enlarging the base with a commitment to align our taxation rates with Asean rates will be an important investor fillip. Adopting best international practice in respect of treaty shopping, seeking tax arbitrage, base erosion and profit sharing and application of GAAR can be part of the same process.

Seventh, clearly-identified programmes that are popular but not populist and contribute to inclusive growth, like Jan Dhan, Swachh Bharat, Clean Ganga, the Digital India and Make in India campaigns should receive tax incentives to invigorate green shoots of investments and back-end infrastructure. Improving the ease of business, particularly enforcements of contracts and permissions in the construction sector as high priority, can make a difference.

Eighth, enhancing agricultural productivity, particularly supply side response, in consonance with changing consumer preference along with orderly non-agricultural job creation is important.

Improved social infrastructure, particularly health and education need an innovative approach. In education, the key issue of guaranteed access must be replaced by improved outcome, through teacher training, and undoing the debilitating feature of the RTE, which has smothered private initiative, is critical. This would be congruous to the new skill inculcation initiatives both in respect of rejuvenating existing institutions and creating new ones.

In the end, any budget is as good as our implementation capabilities. John Keats was right when he said “Nothing ever becomes real till it is experienced”.