The Exchequer is not a cookie jar

Oct 16, 2015

The Centre needs to be more serious about managing its deficit. And, it should not dip into RBI coffers to bridge the gap.

This is the time of the year when the ministry of finance focuses attention on the Union Budget to be presented in February 2016. Over the years the presentation of the Budget has become the most vital policy document of the government and there is pressure to ensure that the Budget Estimates are adhered to. While fiscal consolidation is important there can be major pitfalls as obviously unsuitable measures can be taken to attain targets.

For many decades, the need for fiscal consolidation has been recognised but it was only in 2003 that the Fiscal Responsibility and Budget Management Act was finally brought into force. The Act has been, for all practical purposes, observed in the breach, and from time to time cogent reasons have been put forward for relaxing the targets. In particular, since the global financial crisis of 2008, when major countries went into monetary-fiscal expansionary overdrive, fiscal consolidation in India has lost steam. To the extent that the government is still committed to certain numbers, there have been questions as to how they are being attained.

Growth prospects

On the issue of overall growth, India is presently in a sweet spot. Assessment by various international agencies as also Indian official estimates put the growth for 2015-16 between 7.0 and 7.5 per cent which makes India the fastest growing country in the world. The pressure within India is to grow at an even faster pace. It is often not recognised that the Indian economy is increasingly more integrated with the world economy, and with the global economy continuing to be sluggish it is not realistic to expect India to grow at a faster rate.

India also has to contend with the fact that the savings to GDP ratio has been falling, and presently is around 30 per cent which is insufficient to enable India to grow at a faster rate. Of course, there are internationally acclaimed economists who claim that India is saving too much and should consume more and save less if it wants to grow at a faster rate. This is reminiscent of the 1950s talk about the "demonstration effect" and the concept of "want development". There used to be talk about the "milk bar" economy wherein consumers in the developing world imitated the well-off societies.

To the credit of the Indian economist, VKRV Rao, he claimed that all such an approach would do is leave us in a low level equilibrium trap; his message to Indians was "work harder and save more". It is reprehensible that in this day and age, internationally acclaimed economists want us to save less and consume more. Such seductive doctrines are enticing but can be dangerous to the long-term interests of India.

Fiscal deficit

There is excessive focus on the gross fiscal deficit (GFD)-GDP ratio. With the GDP being so large, and with the methodology changes in computing GDP, focusing on the GFD-GDP ratio can be misleading as slight changes in the denominator can drastically change this ratio. In such a situation it is best to focus on the ratio of GFD-total fiscal expenditure which reveals that the GFD accounts for over 30 per cent of total expenditure. Of course, we would be told that this is no problem as many countries are rapidly increasing their public debt. But when the day of reckoning comes the country is left to fend for itself.

When the pressure builds up there is recourse to imprudent practices to fill the fiscal gap. Illustratively, public sector units (PSU) can be urged to give substantially larger dividends or special extra dividends. Similarly public sector banks (PSBs) can be signalled to give larger dividends.

Again, there is recourse to PSU sales. It is perfectly in order to sell government stake in PSUs but when the family silver is sold the government liabilities should be brought down. Governments have shown no inclination to undertake a matching liquidation of liabilities. One of the most glaring developments in recent years is the unusually large transfer of surplus from the Reserve Bank of India to the government without making any allocation to the contingency and asset development funds. This is indeed imprudent, as various well established norms have been diluted.

Mother of all fudges

Having achieved a quantum jump in RBI profit transfers, there are whispers about transferring the existing funds of the RBI to the government. To say the least, this is sequestration of the RBI's balance sheet. Undertaking fiscal correction by such blatant machinations is nothing short of the mother of all fiscal fudges. The central bank balance sheet is unique and any transfer from the central bank to the government is sheer money creation.

The central bank is one strong financial institution in the country and nothing should be done to damage its credibility. As such, transfer of large profit transfers from the RBI to the government and pulling out resources from the RBI funds and transferring them to the government is scandalous.

Some years ago, an idea floated by a seasoned economist was that the RBI should sell off its entire gold reserves and the rupee profits on the sale, and the balances in the rupee gold reserve could be transferred to the government and thereby bring down the budget deficit. It is fortunate that wiser counsel prevailed and the suggestions were not implemented.

The central bank is not a cookie jar to be dipped into whenever the government is hungry for funds. In the final analysis there is a merger of the central bank and government accounts, and the elementary lesson is that you cannot steal from yourself.

Please Note: This article was first published in The Hindu Business Line on October 16, 2015.

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