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India's economic health was in a very bad shape in the
summer of 1991. In response, the Government of India put
in place a program of economic reforms for promoting growth
which was consistent with a sustainable balance of payments
situation. Today, over thirteen years later, India's
economic health is substantially better.
But all is not well. India currently faces a major
public finance crisis. The combined fiscal deficit of the
central and state governments alone currently adds up to
about 10% of GDP, against 9.4% of GDP in 1990-91 and 9.6%
of GDP in 2000-01. This itself is high, but if one
integrates the finances of the central and state
governments with those of the local governments and public
enterprises to get a measure of India's public sector
deficit, which is a substantially better measure of the
current state of India's public finances than the combined
fiscal deficit of the central and state governments in the
country, the number would be much higher -- about 14 per
cent of GDP!
As a consequence of the continuing high fiscal
deficits, the combined outstanding liabilities of the
central and state governments have risen from 67.8% of GDP
at the end of 1990-91 to 75% of GDP at the end of 2000-01
and to 85.8% at the end of 2002-03. Including the debt of
public enterprises, total public debt is now 107% of GDP,
with contingent liabilities from loss-making public
enterprises alone adding up to 12% of GDP.
High public debt, in turn, has resulted in high debt
serving (interest payments + repayment of debt due). The
Government of India (GOI), for example, has budgeted a debt
servicing of Rs. 3.28 trillion (10.5% of GDP) for 2004-05,
with the resources available for debt serving (revenue
receipts + recoveries of loans and advances + receipts from
privatization of public enterprises - revenue expenditure
other than interest payments) adding up to a mere Rs.
844.29 billion (2.7% of GDP). In other words, resources
available for debt servicing add up to a mere 25.7% of the
debt servicing budgeted for 2004-05. The GOI has budgeted
borrowings to finance this huge gap; in addition, it has
budgeted borrowings to finance its 2004-05 capital
expenditures.
What is worse, high fiscal deficits over time "have
not resulted", as Bimal Jalan has put it recently, "in
increasing the government's ability to spend where higher
expenditure is required, for example, in the maintenance or
expansion of public services. Most of the government
expenditure is now committed to servicing past debt or
meeting salary and other past commitments. We now have a
high fiscal deficit without fiscal empowerment."
("Economics, Politics, and Governance", Vikalpa, Vol. 29,
No. 2, April-June 2004, p. 6.)
And this is how Shankar Acharya has revealed the real
face of this crisis: disappearing rural road networks (no
money for maintenance), hugely under-utilized irrigation
systems (same reason), school teachers without books and
blackboards, health clinics with no medicine,
disintegrating water and sanitation systems, electricity
utilities playing musical chairs with massive arrears while
supplying little power, and so on. (India's Economy: Some
Issues and Answers, Academic Foundation, New Delhi, p. 126.)
India's fiscal instance has considerably weakened her
ability to deal with prolonged adverse shocks. Indeed, the
sustainability of the fiscal instance is extremely
vulnerable to developments such as an increase in interest
rates. India's fiscal health, according to Standard and
Poor's, is the weakest among the countries it rates.
The GOI believes that "At the core of the problem is
the persistently low tax-GDP ratio. The tax-GDP ratio of
the Central Government, which was 10.6 per cent in 1987-88,
fell to a level of 8.8 per cent in 1993-94 and after more
or less stagnating for years, rose to 9.3 per cent in 2003-
04." (Fiscal Policy Strategy Statement, July 2004,
paragraph 32.) Accordingly, the fiscal correction mandated
under the Fiscal Responsibility and Budget Management Act
is proposed to be achieved mainly through collection of tax
arrears and mobilization of additional revenues through
widening of the tax base and other measures.
The GOI's diagnosis of the problem is only partly
correct. Yes, a higher tax-GDP ratio will certainly help.
But what is of critical importance for the GOI today is to
properly manage its expenditures. The truth is that the
GOI's high fiscal deficits have been accompanied by poor
composition of its expenditures and by gross leakages in
its expenditures. Given this, there is no sense in first
raising money through various taxes and then allowing a
good part of this money to be spent in ways which result in
unintended outcomes.
The GOI, therefore, urgently needs to develop a
strategic action plan, including the requisite
incentive-creating, institutional-strengthening and capacity-building
measures, for properly managing its expenditures, and
implement this action plan. One thing that the action plan
will need to focus on is to eliminate distortions in the
allocation of resources. Rather than allowing its
ministers to keep on making off-the-cuff announcements and
chasing hundreds of pending projects, the GOI will need to
articulate its resource allocation policy and ask its
ministers to adhere to it.
The GOI, and for that matter state governments also,
urgently need to eliminate expenditures on the wrong goods
or the wrong people -- expenditures which do not score well
on the following three grounds: the degree to which they
improve efficiency by ameliorating market failures; the
degree to which they improve equity, measured by how much
benefit ends up in the hands of the poor; and the degree to
which they are consistent with the concerned government's
ability to implement the policies that are funded. In case
a given expenditure does not score well on these grounds,
the concerned government may take it off its budget, create
the policy, regulatory and institutional environment
required for involving the private sector in its financing,
and thereby compress its expenditure.
India also faces a major crisis in the electricity
sector, which is largely due to its irrational electricity
pricing policy. The policy is characterized by (a)
allocation of all costs, including costs resulting from
massive thefts of electricity, overstaffing and other
operating inefficiencies, to honest customers of
electricity; (b) huge subsidies for the agricultural and
household sectors; and (c) a tax element included in the
electricity prices for the commercial and industrial
sectors, with the revenue from this tax element being
substantially less than the subsidies to the agricultural
and household sectors. What India urgently needs is an
electricity pricing policy regime that satisfies the
following criteria: it rewards efficiency and penalizes
inefficiency; it creates strong incentives for an
electricity supplier to introduce new products; it
eliminates distortions in the pricing of electricity; it
improves the climate for private investments in India's
electricity sector; and it encourages electricity consumers
to make economically efficient choices.
The situation with pricing in the water and sewerage
sector is no better. Indeed, it is worse than that in the
electricity sector.
And so on.
All this suggests a strong case for improving the
quality of economic management on several fronts in India.
The Economic Management Institute, set up in April 2003,
aims to improve the quality of economic management in India
through a program of consultancy, policy advice, research
and training. The Institute's current areas of interest
include:
- Designing, monitoring and evaluating public expenditure management reforms;
- Economic analysis of infrastructure investment projects;
- Evaluation of performance of public enterprises; and
- Designing rational electricity and water prices.
The Institute is headed by Dr. Anand P. Gupta (Ph.D.,
University of Florida), formerly Professor of Economics at
the prestigious Indian Institute of Management at Ahmedabad
and Public Finance and Fiscal Policy Specialist at The
World Bank.
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