For An Anti-deficit Law

IT'Sofficial: the battle of the fiscal bulge is all but lost, thanks to past sins. Every year, the Central Government borrows just about enough to meet its interest liability on its past internal debts.

Hogging about 5 per cent of the gross domestic product (GDP) and about half of the revenues collected, interest payments have even overshot the Plan expenditure in 1995-96. A situation that makes an internal debt trap and dried-up development a frightening reality by the turn of the century. Leading to proposals from not only a lot of upset economy-watchers but the powerhouse of debt itself, the Reserve Bank of India (RBI), to force a ceiling on public debt stocks and the fiscal deficit.

The numbers are indeed alarming. As the result of a pervasive culture of profligacy, "the combined internal debt of the Central and state governments will reach over seven-and-half lakh crore rupees (that's eleven zeroes after 75) at end 1996-97," estimates Dr Raja J. Chelliah, chairman of the National Institute of Public Finance and Policy and quite the undisputed authority on public debt. That's three-fifths of the GDP in absolute terms. Worse, the combined interest obligation has soared to about Rs 75,000 crore, as the government has been borrowing from the banks at market interest rates of late. This absorbs about 90 per cent of the fiscal deficit, which reflects the Cen-tre's net borrowing. Minus interest payments from the fiscal deficit of 5.9 per cent last year, the primary deficit, as it is called, comes down to only about 1.1 per cent of the GDP. (A zero primary deficit indicates that government expenditure and loans are confined to the limit of total revenues raised.) Admits the Finance Ministry's latest annual report: "This is a legacy of past fiscal deficits accumulated as debt and the rise in interest rates." 

Since the new Government must go in for fiscal expansion, the situation becomes untenable. Interest rates have been high for too long. With the Government mopping up much of the credit available, a longer delay in bringing them down might set off a recession. Even its borrowing programme shows no sign of slackening. Said RBI Governor R. Ran-garajan recently: "In absolute terms, the gross and net market borrowings of the Centre in 1996-97 are still high, making it difficult to place them in the market. The high level of borrowing is putting pressure on interest rates." The RBI has already raised three-fifths of the Government's gross borrowing programme for the year.

The choice, ironically, is left between monetising and non-monetising. That is, to borrow ad hoc from the RBI and fuel inflation or mop up funds from the market and raise the interest burden. Leading to a vicious circle of avoidable monetary restraint because there isn't enough fiscal compression. The high int-erest rate regime, notes the World Bank Country Economic Memorandum (CEM), is a result of liberalisation of financial markets. Meant to curb money supply growth, it has hit both the Government and private sector, though in varying degrees. Money supply growth, says the ministry report, declined from 22.3 per cent to 13 per cent last fiscal year, falling below the 15 per cent target (this year's target is 16 per cent), while net RBI credit to the government went up by a quarter. The CEM, which experts deem as sacred as the Government's annual Economic Survey, actually reflects a drop in absolute Government expenditure. Non-interest expenditure is the lowest ever at 11. 5 per cent. As a result, it expects both fiscal deficit and revenue deficit to drop. (This is not to be confused with the IMF's forecast of a 10 per cent fis-cal deficit, taking into account fiscal deficits of both the Centre and states, plus the borrowings of all Central undertakings and PSUs. The World Bank calls it the consolidated public sector deficit). But, the CEM warns, the marginal real interest rates the government pays on its domestic debt is now close to the economy's growth rate, constituting a major destabilis-ing force which may undo all the gains from the past few years of reforms.

Historically, Government expenditure has indeed gone down—the CEM details declines in all components: wages and salaries, commodities and services, grants and other transfers. The states, which account for 56 per cent of the expenditure, have little room for manoeuvre—they can't tell the RBI to print money and most of their borrowings are determined by the Centre when finalising Plan outlays. Unfortunately, most of the spending cut has taken a heavy toll on capital expenditure, which slumped from 40.1 per cent of total expenditure in 1990-91 to 29.6 per cent last year. Simultaneously, so did gross capital formation out of budgetary resources, from 6.6 per cent to 5.1 per cent. Instead, the revenue deficit went up erratically, nullifying all the gains from tax reforms. Clearly, the Government is borrowing to fund nonproductive expenditure, forcing the spotlight on interest payments, an issue of major discomfort to the Finance Ministry.

The RBI proposal to place a statutory ceiling on total debt stocks at 35 per cent of GDP and the rise in debt (the fiscal deficit) to 15 per cent of total expenditure could not have come at a better time, but it's ambitious and finds few takers in the ministry or among economists. Dr Bimal Jalan, Planning Commission member-secretary, has been calling for a legal limit on the size of fiscal and revenue deficits. The Constitution does provide for such a limit, but it's not mandatory and, though frequently debated by Parliament committees since the '60s, has never been invoked, say ministry sources.

Article 292 says: The executive power of the Union extends to borrowing upon the security of the consolidated fund of India " within such limits, if any, as may from time to time be fixed by Parliament by law and to the giving of guarantees within such limits, if any, as may be so fixed ."; The scope of this provision is limited to borrowings through market loans, treasury bills and external loans which flow into the Consolidated Fund. It doesn't cover the considerable amount of central draft on household small savings, provident fund, public deposits, etc. Ministry sources say debt is only a part of the total liabilities and, to make use of any statutory control, the Constitution may need to be changed or specific laws formulated.

Historically, such a limit has been shunned by the ministry as too inflexible, a fact the US administration has realised to considerable discomfort, explains S.L. Rao, former director general of the NCAER. The Gramm-Rudman proposal aimed at an absolute constitutional limit on Government deficits, the so-called balanced budget amendment. But the US, it's well known, has one of the worst records in fis-cal deficit, a fact that doesn't much harm its world standing as it would India's, points out Dr Charan Wadhva, professor at the Centre for Policy Research (CPR).

Citing a survey of 57 countries, Dr Jalan says automatic credit or overdraft facilities were prohibited in over half, like Chile or New Zealand. The absolute powers of Germany's Bundesbank compel many to accept it as the ideal central bank. The RBI is modelled on the Bank of England; it has separate accounts and returns only a small portion of the total interest it earns from the Government on a debt that comes into existence merely through credit creation, its primary function, says Che-lliah. As if the bank is kept solvent by the Government's compulsion to issue bills!

A legal limit is crucial also because of the Centre's dismal record in adhering to self-imposed restrictions. Nor can the RBI say no to the Government. In 1994, it made a formal pact with the RBI to limit ad hoc borrowings to Rs 6,000 crore at the fiscal year-end, to be phased out totally in '96-97. The limit was scaled further down to Rs 5,000 crore in '95-96, only to be promptly flouted, raising credit well above the intra-year ceiling of Rs 9,000 crore, as

per the ministry report. Says Subhasis Gangopadhyay, professor at the Indian Statistical Institute: "As long as the RBI is not independent of the Finance Ministry, ceilings are meaningless." While Parliament could help the government achieve what it must, it could also mean a majority government would lose no time in going back to Parliament and changing the ceiling.

Ministry sources stress that of late, the opening up of the economy has laid bare other interesting sources of finance—foreign funds. Foreign investment has gone up from $68 million of only direct investment in '90-91 to $4,077 million last fiscal year, including $1,981 million of FDI and $1,842 million in FII flows. In fact, the key to the finance minister's estimate of a 4 per cent fiscal deficit target is the assumption of a magic fig-ure of $10 billion FDI every year.

In 1995, India received only $1.2 billion of a total $90 billion FDI that went to developing countries. Apart from this, FII flows of over $1,500 million in the past three years have raised hopes of cheap foreign equity. But critics are reluctant to depend on 'hot money'. For instance, Euroissues netted only $204 million last year, compared to $2,078 million in the previous, resulting in a big depletion of forex reserves. Former RBI governor S. Venkita-ramanan points out that in an absolute craze to curb the fisc, the comparative high costs of foreign equity is lost sight of.

Independent estimates suggest a ceiling may be futile as the previous governments have ensured that debt servicing remains high for the next 20 years. Gangopadhyay is sharper: "It's just a whitewashing to shift public attention to the fiscal deficit, from the issue which is important: expenditure control." A more realistic way is to look at other means of generating resources for productive expenditure, while retaining the emphasis on restructuring and rationalising current expenses. The newly set-up Expenditure Commission is expected to do its job, though the question here is of the Government's will. In the US, this job was excellently executed by the Packard (of Hewlett-Packard fame) Commission. Which brings us to the urgency of generating a revenue surplus. Says CPR'S Isher J. Ahluwalia: "It's important to look at the level of public savings and link it to returns on public investment." Says a ministry official: "We're keen to reduce the revenue deficit to the extent that it gives a picture of public savings." 

That picture is pretty grim. The CEM puts India fifth on the list of highest savers, with a 22.4 per cent savings rate, but public savings account for a miserable 1.7 per cent of that. The Centre's gross savings declined from a negative Rs 10,502 crore in '90-91 to a negative Rs 17,773 crore last year, even as internal debt doubled. About half of outstanding Government loans go to states, Union territories and the public sector. Insofar as the fiscal deficit outlines the change in debt stock, it also reflects the gap in public investment over savings. Rather, as the updated Survey puts it, "it represents the Centre's draft on the savings available to the economy for private investment". Since most experts concede the near-impossibility of improving public savings in the short term, it leaves only one way out of the mess—to reduce the stock of old debt.

In other words, retire public debt through disinvestment. That's an area where economists of all hues concur, specially since the Government has allowed past disinvestment proceeds, however meagre, to be swallowed in current consumption. The issue is whether there are any large-scale takers for offloadable PSUs. Dr S.P. Gupta, director of the Indian Council for Research in International Economic Relations, thinks most PSUs are goldmines, given their undervalued tangible assets. The offer of a controlling interest will interest many. Even the Survey admits "at least 26 per cent of the outstanding marketable debt could be retired by selling public assets. A transfer of controlling interest is likely to fetch a higher price of equity than selling a small portion of the total equity." 

The message is clear: the Government must curb its own expenditure, bring down interest rates, allow private investment to widen, and increase its own savings rate and return on investment, to sustain a high growth rate of 5-6 per cent over a medium term. To borrow to spend on frills is a crime; to borrow to invest and develop is not.