REFORMING MANAGEMENT OF THE GOVERNMENT OF INDIA’S EXPENDITURES:

SOME THOUGHTS[*]

 

 

ANAND P. GUPTA[†]

 

 

1.  Introduction

 

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, about fourteen 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 adds up to 9.4% of GDP.  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,[1] the number would be much higher!

 

            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 87.1% at the end of 2003-04.[2] 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 (The World Bank, 2004, p. 13).

 

            High public debt, in turn, has resulted in high debt servicing (interest payments + repayment of debt due).  The Government of India (GOI), for example, has budgeted a debt servicing of Rs. 381,929 crore (10.9% of GDP) for 2005-06, with the resources available for debt servicing (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. 50,633 crore (1.4% of GDP).  In other words, resources available for debt servicing add up to a mere 13.3% of the debt servicing budgeted for 2005-06.  The GOI has budgeted borrowings to finance this huge gap; in addition, it has budgeted borrowings to finance its 2005-06 capital expenditures.

 

What is worse, high fiscal deficits over time “have not resulted”, as Jalan (2004, p. 6) 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.”  And this is how Acharya (2003, p. 126) has revealed the real face of India’s public finance 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 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. 

 

The GOI (2004b, p. 33) 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.”  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 is necessary but, given India’s current public finance crisis, a higher tax-GDP ratio alone will not be sufficient.  The GOI also needs to save money through minimization, if not elimination, of distortions in the allocation of its expenditures, as also through minimization, if not elimination, of leakages in its expenditures – a rupee saved through reduction in these distortions and leakages is at least as good as raising an additional rupee through taxation.  Put differently, the GOI urgently needs to reform the management of its expenditures, with a view to strengthen the GOI’s spending-outcome link. 

 

How weak is the GOI’s spending-outcome link?  And what must be done to strengthen this link?  This paper attempts to answer these extremely important public policy questions. 

 

The plan of the paper is as follows.  Section 2 identifies and articulates the various breaks in the chain between government spending and its transformation into intended outcomes.  Section 3 takes a careful look at the GOI’s 2005-06 budget and evaluates its expenditure management function.  Section 4 presents some ideas on how the GOI may strengthen its expenditure management function.  Finally, Section 5 presents some concluding remarks.

 

 

 

 

2.   Breaks Between Government Spending and Outcomes

 

One can identify six breaks in the chain between government spending and its transformation into intended outcomes.  Firstly, a government may spend on the wrong goods or the wrong people.  Secondly, even when a government budgets to spend money on the right goods or the right people, the composition of spending may not be appropriate.  Thirdly, even when the composition of spending is appropriate, the money may not reach the intended service provider.  Fourthly, even when the money reaches the intended service provider, the service provider may not have the capability to implement the project that is funded.  Fifthly, even when the service provider has the capability to implement the project that is funded, the service provider’s incentives to provide the service may be weak.   Finally, even if the services are provided, people may not take advantage of them.[3]

 

2.1  Spending on the Wrong Goods or the Wrong People

 

A government spending which neither improves the supply of public goods, nor benefits the poor, can be called a spending on the wrong goods or the wrong people.  Public goods, which are defined as goods characterised by non-excludability and non-rivalness, improve efficiency by ameliorating market failures.  These essentially are goods which cannot be bought and sold in markets.  Adequate private production of these goods will not take place because the benefits are so widely dispersed that no private firm will have the incentive to provide them.  Examples include defence services, clean air, weather service, tsunami warning system, justice delivery, basic science, public health,  rural roads, and flood control. 

 

 A government may not spend adequately on maintenance of roads, yet it may subsidise its employees’ consumption of electricity.  Similarly, a government may not spend adequately on public health, yet it may provide LPG subsidy which largely benefits the higher expenditure groups in urban areas. 

 

2.2  The Composition of Spending May Not Be Appropriate

 

Even when a government budgets to spend money on the right goods or the right people, the composition of spending may not be appropriate.  A government may allocate money for, say, operation and maintenance of roads, but most of that money may be for funding wage and salary payments and other employee costs, with grossly inadequate money available for funding material and other requirements.

 

2.3  Money May Not Reach the Service Provider

 

Even when the composition of spending is appropriate, the money may not reach the intended service provider.  This may happen either because the government may not, for one reason or another, launch a given project during the year in which it was supposed to be launched, or because the government may run short of money (over-optimistic revenue forecasts may allow the inclusion of a “wish-list” of expenditure initiatives in the budget, with cuts becoming inevitable when the revenue doesn’t arrive), or because the government may transfer the money to a personal deposit account in the Public Account, or because the government may divert the money for some other use.  What may also happen is that because of leakages in procurement, the intended service provider (e.g., a school) may receive the supplies (say, tables and chairs) at inflated prices, or of a lower quality than specified.  Or the money may reach the intended service provider or beneficiary, but not in time.

 

2.4  Service Provider May Not Have the Required Capability

 

Even when the money reaches the intended service provider, the service provider may not have the capability to implement the project that is funded.  Mavalankar (2003) reveals the almost complete lack of managerial capacity in the large maternal health programmes that the central and state governments run, and concludes that “…very limited capacity of the top technical officers in the area of maternal health is a major constraint … and unless this constraint is removed, more investment in maternal health will not result in faster progress….”   

 

2.5  Service Provider’s Incentives to Provide the Service May be Weak

 

Even when the money reaches the intended service provider, the service provider’s incentives to provide the service may be weak.  Doctors, for example, may not want to work in villages because of extremely poor quality of housing, absence of facilities to keep children and family, and few opportunities for career promotion.  Similarly, teachers’ incentives to work in villages may be weak because of very low  salary, lack of adequate facilities, and inadequate supervision.  This, in turn, may result in large-scale absenteeism of teachers.

 

2.6  People May Not Take Advantage of Government Services

 

Even if the services are provided, people may not take advantage of them.  For example, parents may pull their children out of government schools or not take them to government hospitals.  They may do so because of their perceptions about the quality of education in government schools and the quality of medical care in government hospitals, which may be due to, say, inadequate budgetary allocation for these services.  These demand-side responses may result into a low level of government services which, in turn, may weaken the link between government spending and desired outcomes.

 

3.  The GOI’s 2005-06 Budget and Evaluation of its Expenditure Management Function

 

The GOI has budgeted a total expenditure of Rs. 514,344 crore (14.6% of GDP) for the fiscal year 2005-06, of which Rs. 446,512 crore (86.8%) is on the revenue account and the balance on the capital account.  Table 1 presents the constituents of the expenditure portfolio.

 

 

Table 1

 

Government of India’s 2005-06 Budget:

Constituents of Expenditure Portfolio

 

               Constituent                                    Expenditure (Rs. Crore)    % of Total Expenditure

 

               Interest Payments                                                            133,945                             26.0

 

               Pensions                                                              19,542                                               3.8

 

Defence                                                              84,500                             16.4

 

Police                                                                  14,772                                               2.9

 

Fertilizer Subsidy                                                              16,254                               3.2

                                                                                         

Food Subsidy                                                      26,200                               5.1                                                                                     

Petroleum Subsidy                                               3,644                               0.7

 

Support to Public Enterprises                           18,854                                               3.7

 

Rural Family Welfare Services                           1,869                                               0.4

 

Reproductive and Child Health                           1,381                                               0.3

Project

Sarva Shiksha Abhiyan                                         7,156                                               1.4

 

Mid-Day Meal Programme                                 3,011                                               0.6

 

Integrated Child Development                            3,142                                               0.6

Services

Sampoorna Gramin Rozgar Yojana                     3,600                               0.7

 

National Food for Work Programme                 5,400                                              1.0

 

Rural Housing                                                       2,498                                              0.5

 

Accelerated Rural Water                                    3,645                               0.7

Supply Programme

 

Pradhan Mantri Gram Sadak Yojana                   3,810                                              0.7

 

Roads and Bridges                                               6,221                               1.2

 

Support to State and Union                                67,165                                            13.1

Territory Governments

 

 

Source: Based on data in Government of India (2005b), Government of             

               India (2005c), and Government of India (2005d).

 

One does not see a strong case for the GOI to incur some of these expenditures, as they neither correct market failures nor improve equity.  Take, for example, the

petroleum subsidy for which the GOI has budgeted an allocation of Rs. 3,644 crore (subsidy on LPG and kerosene for PDS: Rs. 3,600 crore; freight subsidy: Rs. 44 core).  The National Institute of Public Finance and Policy, which was asked by the GOI to prepare a blue print to accomplish the National Common Minimum Programme’s objective of targeting all subsidies “sharply at the poor and the truly needy like small and marginal farmers, farm labour and the urban poor” (Government of India, 2004c, p. 19), has reported: “LPG subsidy benefits largely the higher expenditure groups in the urban areas, and may be regressive.  With regard to kerosene, on a per capita basis the urban areas receive a larger subsidy.  The limited availability of subsidized kerosene in rural areas biases its use in favour of lighting rather than cooking.  Moreover, the kerosene subsidy in rural areas is regressive as higher expenditure groups receive more subsidized kerosene than lower expenditure groups.  Kerosene subsidy is prone to misutilisation with about half the subsidized kerosene supplies diverted and never reaching the intended groups.  These arguments suggest that the LPG and kerosene subsidies are ineffective in serving the desired objectives.  Therefore, the removal of LPG subsidy in a gradual manner, or at least a substantial reduction in the subsidy element, may be recommended.  A more cautious approach may be justified in the reduction of kerosene subsidies since about a half of the rural households use kerosene primarily to light their homes….  Coupons may be issued only to poor ration card holders with entitlement to purchase kerosene from a retailer at the subsidized price” (Government of India, 2004d, p. 19).

 

Take another example.  The GOI has budgeted an allocation of Rs. 18,854 crore for public enterprises, of which equity investment accounts for Rs. 14,040 crore, loans for Rs. 4,812 crore, and grants for Rs. 2 crore.[4]  The entire equity investment and loans of Rs. 3,554 crore are meant to help public enterprises in financing their investments during 2005-06, with the balance loans of Rs. 1,258 crore allocated for (a) meeting shortfall in resources of public enterprises,  (b) financing revival schemes of public enterprises, and (c) financing voluntary separation scheme and statutory dues of public enterprises; the grants are meant to enable public enterprises implement voluntary retirement schemes.  Why should the GOI help public enterprises in financing their investments?  If State and Union Territory (with legislature) Governments can be asked to directly raise resources from the market, why shouldn’t the enterprises belonging to the GOI, other than those producing public goods or improving equity,[5] also be asked to do so? 

 

Further, the budgetary allocations do not reflect any realization of the weaknesses in the chain between outlays and their transformation into desired outcomes.  And this when the GOI knows what these weaknesses are and has confessed them: “Despite isolated efforts to merge schemes targeting the same set of beneficiaries as also to remove schemes which have outlived their utility, the portfolio of Plan schemes of the government has increased in size and complexity over the years.  Under many schemes, the budgetary outlays are so small as to be practically ineffective in achieving the intended objectives….we have some systemic problems to deal with.  The deficiencies in the delivery mechanism frustrate the good and sincere intentions behind the Government’s plans and schemes.  A number of Ministries/Departments usually release funds to a large number of implementing agencies – state governments, autonomous bodies, district level agencies and NGOs.  Quite often, the funds released by the Central Government remain for long with intermediaries and may even be temporarily diverted for unintended purposes, resulting in accumulation of substantial “unspent balances” with implementing agencies.…Central Government’s funds have become an interest free source of financing cash deficits….tendency to ‘park’ Government funds and make undue advance payments merely to avoid lapse of the budgeted amounts….the overt focus on outlays and neglect of outcomes has led to serious shortcomings in realizing the developmental objectives” (Government of India, 2005f, pp. 37, 39,41 and 47).

 

This raises the extremely important issue of why the Finance Minister, fully aware of all this, has focused so much on outlays in his budget as if it is increased outlays which matter.  “Forty seven per cent of children in the age group 0-3 are”, the Finance Minister said, “reportedly underweight.  Supplementary nutrition is an integral part of the ICDS scheme.   I propose to double the supplementary nutrition norms and share one-half of the States’ costs for this purpose.  I also propose to increase the allocation for ICDS from Rs. 1,623 crore in BE 2004-05 to Rs. 3,142 crore in BE 2005-06” (Government of India, 2005e, p. 5).

 

What exactly is the Finance Minister trying to say?  Is inadequacy of money the issue?  As against the 2004-05 budget estimate of Rs. 1,623 crore for the ICDS (Integrated Child Development Services), the revised estimate stands at Rs. 1,490 crore.  If the authorities responsible for managing the ICDS are not able to spend even Rs. 1,623 crore, what makes the Finance Minister expect that they will be able to spend an outlay of as much as Rs.  3,142 crore?  And how much reduction in the percentage of underweight children in the 0-3 age group can one expect from this outlay of Rs. 3,142 crore?  Alas, the budget is deafeningly silent on these extremely important questions.

 

Given all this, what does one make out of the initiatives that the GOI has announced to reform the management of its expenditures?  These initiatives include:

 

·       put in place, during 2005-06, a mechanism to measure the development outcomes of all major programmes (Government of India, 2005e, p. 22);

·       carry out a review of the quality of investment and of outcomes (Government of India, 2005f, p. 25);

·       all departments will be required to…make benefit-incidence analyses (Government of India, 2005e, p. 6);

·       ensure that programmes and schemes are not allowed to continue indefinitely from one Plan period to the next without an independent and in-depth evaluation (Government of India, 2005e, p. 22); 

·       encourage public enterprises to borrow directly from the market on commercial terms (Government of India, 2005f, p. 35);

·       revised and updated “General Financial Rules”, with focus on greater delegation of authority to administrative ministries in managing their financial affairs, will be brought into force by July 1, 2005 (Government of India, 2005f, p. 37);

·       a review of norms governing re-appropriation will be carried out and specific proposals will be placed before the Public Accounts Committee by September 2005 for its consideration, with a view to giving the ministries/departments greater flexibility in managing their budgets with concomitant incentives and disincentives (Government of India, 2005f, p. 37);

·       ministries/departments will be asked to initiate action to obtain utilization certificates, audit certificates and expenditure statements and ensure that all are received, wherever due, latest by June 30, 2005, and no funds will be released to any entity in default without express clearance from the Ministry of Finance (Government of India, 2005f, pp. 37-39);

·       State Governments will be required to send monthly expenditure returns in respect of all Central Sector Schemes and Centrally Sponsored Schemes, including those funded from cesses, and also expenditure on State Plan (Government of India, 2005f, p. 39);

·       each district level autonomous body receiving more than Rs. 10 crore from the GOI’s Ministries of Rural Development, Human Resource Development, and Health and Family Welfare will be required to open a separate bank account in one of the designated banks and arrangements will be made to have the central budgetary transfers electronically credited to their accounts and to have the banks report the cash balance position in a prescribed format to the designated authorities in the GOI, with this entire arrangement to be put in place latest by December 2005 (Government of India, 2005f, p. 39);

·       the GOI’s ministries will release a summary of their monthly expenditure through their websites and in particular disclose scheme-wise funds released to different States (Government of India, 2005f, p. 39);

·       a special drive will be taken up to clear arrears in taking appropriate action on audit reports (Government of India, 2005f, p. 39); and

·       the GOI is requesting the Comptroller  and Auditor General of India to suggest a roadmap for accounting reforms (Government of India, 2005f, p. 47).   

 

Given the Finance Minister’s awareness of the various weaknesses in the management of the GOI’s expenditures, one expected him to focus on fixing these weaknesses, rather than on raising outlays.  There is reason to believe that it is the political economy of budget-making in the present coalition government that has compelled him to do so.  Given this, one can expect him to walk the talk and start fixing the various weaknesses in the management of the GOI’s expenditures.  In that event, the actual outlays may be substantially lower than the budgeted numbers. 

 

Where do we go from here?   My feeling is that the Finance Minister and his colleagues really want to reform the management of the GOI’s expenditures. They have already come up with an impressive list of initiatives.   But it is not a comprehensive list.  One can certainly add to it.   Section 4 presents some ideas.

 

  4.  Strengthening the GOI’s Expenditure Management Function

 

To begin with, we will need to agree on the desired outcomes and set targets for achieving them.[6]  Take, for example, the Finance Minister’s statement that 47% of children in the 0-3 age group are reportedly underweight (Government of India, 2005e, p. 5).  This is the average for the country, which suggests that in certain districts of the country the percentage may be much higher.  And in those districts, the percentage of underweight children in the 0-3 age group in poor families may be still higher.  This raises the issue of how one should go about setting the target for reducing the percentage of underweight children in the 0-3 age group during a given period -- just one target for the whole country, or different targets for different states, or different targets for different districts, with focus on children in poor families?  I believe we should set district-wise targets, with relatively higher allocations for districts with higher percentages of underweight children in the 0-3 age group.  In that case, the monitoring too will have to be at the district level.

 

Secondly, we will need to organise surveys to track the GOI’s outlays: what currently happens to a given budgeted outlay?  Does it achieve the desired outcome in the most efficient way? If not, why?  Does it reach the intended service provider or the intended beneficiary?  Does the service provider have the capability to implement the project in question? Does the service provider have the incentives to provide the service in question?  Do the people who are supposed to benefit from the service, take advantage of it?  How much of the budgeted outlay is spent at the end of the financial year?[7]  In case the budgeted outlay does not reach the service provider or the intended beneficiary, why?  It will be useful for these surveys to draw on the results of the GOI’s first three initiatives listed in Section 3 above.

 

Thirdly, based on the results of the surveys to track the GOI’s outlays, we will need to develop a strategic action plan, including the requisite incentive-creating, institutional-strengthening and capacity building measures, for converting the budgetary outlays into desired outcomes, and implement the action plan.  The action plan may differ from outlay to outlay and, for an outlay for a given project, from one district to another.

 

Fourthly, we will need to subject the implementation of the action plans to an independent, rigorous evaluation, with focus on whether the targeted outcomes are achieved.  In case they are not achieved, how much is the deficiency, why, and what are the corrective actions that need to be taken? 

 

Finally, we need to abolish the distinction between Plan expenditure and non-Plan expenditure.  Of  the  total expenditure of Rs. 514,344 crore (14.6% of GDP) which the GOI has budgeted for the fiscal year 2005-06, Plan expenditure amounts to Rs. 143,497 crore (27.9%) and non-Plan expenditure to Rs. 370,847 crore (72.1%).  As much as 80.8% of the Plan expenditure in on the revenue account, with the balance on the capital account.  Expenditures on schemes included in a Plan are labeled as Plan expenditures, whereas continued expenditures on these schemes after completion of that Plan are labeled as non-Plan expenditures.  A popular conception is that Plan expenditures are developmental (and therefore good) while non-Plan expenditures are wasteful (and therefore bad).  In practice, this is not necessarily the case.   Take, for example, non-wage expenditure on the operation and maintenance of a road constructed during a Plan which is now over.  This is a non-Plan expenditure, but certainly not a bad expenditure.  Similarly, while salary to a teacher in a primary school set up during the current Five Year Plan will be treated as a Plan expenditure, salary to a teacher in a primary school set up during the previous Five Year Plan will be labeled as a non-Plan expenditure.  One can give many such examples. The Plan/non-Plan distinction doesn’t sound rational, distorts allocation of resources, and therefore must be abolished.

 

5.  Concluding Remarks

 

The Finance Minister concluded his February 28, 2005 budget speech by quoting Amartya Sen.  This is what he said: “One of India’s proudest sons, Dr. Amartya Sen, argues in his book “Development as Freedom” that development is a process of expanding the real freedoms that people enjoy.  He says, “Growth of GNP or of individual incomes can, of course, be very important as means to expanding the freedoms enjoyed by the members of the society.  But freedoms depend also on other determinants  such as social and economic arrangements (for example, facilities for education and health care) as well as political and civil rights.”  The UPA Government accepts this ethical dimension to the discussion of economic issues, and in this Budget I have attempted to reflect that dimension” (Government of India, 2005e, p. 32).  Giving ethical dimension to the discussion of economic issues will require far-reaching reforms in the management of the GOI’s expenditures.  This is a major challenge.  The Finance Minister has accepted this challenge.  The country now looks forward to his walking the talk.