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Need for a New Medium-Term Fiscal Strategy

Policymakers must see that there is an inconsistency between the new emphasis on inclusive growth and the rigid fiscal strategy they want to follow. Fiscal prudence should not be discarded but the conentional focus on a narrow interpretation of fiscal and revenue deficits harms the cause of balanced growth. There is also a need to reorient government expenditure and to mobilise resources by ending and even rolling back the increasing regressivity in direct taxation. We need, in other words, a new fiscal strategy for the medium term.

Need for a New Medium-Term Fiscal Strategy

S L Shetty

of GDP) and significantly, the bulk of this rise in the fiscal deficit – about Rs 1,05,613 crore out of Rs 1,93,228 crore – was on a ccount of these uncovered expenditures. The stimulus packages, on the other hand, added up to a meagre amount of Rs 40,000 crore or thereabouts.

Policymakers must see that there is an inconsistency between the new emphasis on inclusive growth and the rigid fiscal strategy they want to follow. Fiscal prudence should not be discarded but the conentional focus on a narrow interpretation of fiscal and revenue deficits harms the cause of balanced growth. There is also a need to reorient government expenditure and to mobilise resources by ending and even rolling back the increasing regressivity in direct taxation. We need, in other words, a new fiscal strategy for the medium term.

The author wishes to thank R Krishnaswamy, K Srinivasan and other members of the EPWRF for the help rendered in preparing this article.

S L Shetty ( is with the EPW Research Foundation, Mumbai.

Economic & Political Weekly

september 5, 2009

he budget for 2009-10 received more than the usual interest, both before and after its presentation in Parliament, essentially because of the e xtraordinary economic situation faced by the country in the face of the current g lobal financial and economic turmoil. The budget was expected to provide a nswers to a wide variety of questions that have surfaced with the confluence of a number of developments.

1 Confluence of Developments

First, the high growth phase of five years 2003-04 to 2007-08, particularly of manufacturing, was brought to a precipitate halt in early 2008 following the sledgehammer kind of monetary actions taken to fight inflation. Second, the slowdown in growth due to domestic reasons coincided with the rapid unfolding of the global crisis on the Indian economy in the form of reduced capital flows and corporates finding it difficult to resort to external borrowings, as also the dampening of export d emand. Third, there occurred an acute deterioration in the fiscal health of the economy which was hidden in the underprovision of expenditures in the original budget of 2008-09 (Rao 2009).

These uncovered provisions related to pay and pension revisions as per the Sixth Pay Commission recommendations, additional funds for food and fertiliser subsidies, funding of the loan waiver scheme, and additional allocations to various flagship programmes including the National Rural Employment Guarantee Scheme (NREG Scheme). When the supplementary grants were sought and finally when the revised estimates for 2008-09 were presented, it became clear that the gross fiscal deficit had galloped from Rs 1,33,287 crore (2.5% of GDP) in 2008-09 budget e stimates (BE) to Rs 3,26,515 crore in the revised estimates (RE) for the year (6.0%

vol xliv no 36

In fact, the size of this uncovered expenditure would be even larger, if extrabudgetary liabilities created in the form of special bonds for food, fertiliser and p etroleum companies were taken into a ccount (worth Rs 95,942 crore or 1.8% of GDP during 2008-09).

Finally, all the above complex developments have occurred when the authorities have been compelled to seek a radical transformation of the development strategy in favour of inclusive growth, because admittedly the benefits of development have not percolated enough to the poorer sections of society.

The entire policy environment, including that enunciated in the Eleventh Fiveyear Plan (2007-08 to 2011-12) and in the president’s address to the new Parliament, based on the electoral promises of the new government, has imposed an onerous burden on the Union Finance Minister to a ccommodate the programmes and policies geared towards inclusive growth even as he has faced tremendous pressures b ecause of (a) vastly reduced revenue r eceipts, and (b) higher expenditure commitments as referred to above.

The extent of the revenue slippages may be gauged from the steady reductions in estimates of the tax to GDP ratio for the same budget year 2009-10 as well as for the subsequent forecast period 2010-11 and 2011-12 (Table 1, p 48). The estimate of gross tax to GDP ratio for 2009-10 was 13.5% as anticipated in medium-term forecasts contained in the relevant documents of the 2008-09 budget, but it was reduced to 11.1% in the interim budget and now it is placed at 10.9% in the full year budget for the same year. In these measurements based on the government’s medium-term projections, the underlying cause for the decline in the tax to GDP ratio has been the anticipated slowdown in economic growth and the consequential adverse impact on tax collections.

Table 1: Fiscal Indicators – Selected Rolling Targets as Percentage of GDP ments and accelerate growth,

As Per the Budget 2008-09 (February 2008)

expand the tax revenue base

2007-08 2008-09 Target for (RE) (BE) 2009-10 2010-11 and thus finally help the sys-

Revenue deficit 1.4 1.0 0.0 0.0 tem to reduce the fiscal deficit.

Fiscal deficit 3.1 2.5 3.0 3.0 The containment of the fiscal

terminal annum 2011-12” (p ix). We are in the middle of the Plan and there have arisen serious gaps in these investment programmes. Also, a major part of such bulky investments has to be in the public sector and this requires sizeable expenditure support from the central government.

Secondly, it has been proven – and even the Planning Commission has accepted – that targeting zero revenue deficits for states by 2008-09 will have serious repercussions on state plan expenditures, particularly in the social sector, which are essentially in the form of revenue and not capital expenditure (Planning Commission 2005: 43-44). Because of the mandatory requirements for states to target a zero revenue deficit by 2008-09 so as to enjoy debt and interest relief as recommended by the Twelfth Finance Commission, the average revenue deficits of states have even slipped into negative territory (Table 2).

In fact, the backlogs in achieving the stated goals are much more serious in the social sector, as a result of which the country’s progress made under the millennium development goals (MDGs) has been extremely slow (CSO 2005). To quote a more studied report of the Planning Commission (2005: 32-33):

Table 2: Key Fiscal Indicators – Centre and States

(% to GDP)

Year Primary Revenue Gross Outstanding
Deficit Deficit Fiscal Deficit Liabilities*
1990-91 4.1 3.3 7.8 55.2
2001-02 1.5 4.4 6.2 60.0
2003-04 0.0 3.6 4.5 63.0
2007-08 -0.9 1.1 2.7 60.1
2008-09 RE 2.5 4.5 6.1 58.9
(2.6) (4.6) (6.2)
2009-10 BE 3.0 4.8 6.8 59.7
1990-91 1.8 0.9 3.3 22.5
2001-02 1.4 2.7 4.1 30.3
2003-04 1.5 2.3 4.4 33.2
2007-08# -0.6 -0.9 1.3 25.8
2008-09 RE# 0.7 -0.2 2.5 25.2
2009-10 BE# 0.9 0.4 2.7 25.3
1990-91 5.0 4.2 9.4 64.7
2001-02 3.7 7.0 9.9 76.0
2003-04 2.1 5.8 8.5 81.4
2007-08 -1.3 0.2 4.0 73
2008-09 RE 3.4 4.4 8.6 72.6
2009-10 BE 4 5.2 9.5 74.4

* : Includes external liabilities at historical exchange rates. # : Data from 2007-08 onwards pertains to 22 state governments, of which 14 are vote on account. 1 Negative sign indicates surplus. 2 Figures in parentheses relate to provisional accounts. Source: Reserve Bank of India,Various Credit Policy Statements.

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Economic & Political Weekly

Gross tax revenue 12.5 13.0 13.5 14.0 deficit would, of course, be

Revenue deficit 4.4 4.0 0.0 0.0 and the RBI managing liquidity
Fiscal deficit 6.0 5.5 3.0 3.0 in a calibrated manner so as to
Gross tax revenue 11.6 11.1 14.4 15.0 minimise any additional aver-
As Per the Budget 2009-10 (Full) (July 2009) 2008-09 2009-10 Target for (RE) (BE) 2010-11 2011-12 age interest cost on the central and state budgets following
Revenue deficit 4.4 4.8 3.0 1.5 i ncreased outstanding debt.
Fiscal deficit 6.0 6.8 5.5 4.0 But that is not all. The re-
Gross tax revenue 11.6 10.9 11.9 12.4 cent social and political con-

Source: Centre’s Budget Documents (2009-10).

At this stage, it is also necessary to take note in parenthesis of an important implication of the strategy of inclusive growth which does not appear to have figured in the current official discourses on the subject. That is, its success depends not only on social orientation in public expenditures but also on a somewhat improved degree of progressivity in the tax system. It is only such a comprehensive system of inclusiveness in development that alone can produce enduring results. In Section 3 of this article dealing with the contours of a medium-term fiscal strategy, we address specifically this question of the need for progressivity in taxation.

2 Excessive Focus on Deficits

The intense debate on the budget has been essentially dominated by the concerns expressed on the unusually high government borrowings and the consequential widening of the gross fiscal deficit. But, the environment of the reduced tax-GDP ratio, the imperatives of not only reverting to a higher growth path but also one of making the growth process much more inclusive, and the constraints on liquidity arising from sharply reduced capital inflows from abroad, cannot but make the authorities and the community at large accept the reality of a higher fiscal deficit. This does not mean that the objective of better fiscal prudence has to be given the go-by. It is just that a larger fiscal deficit now would help us to achieve fiscal prudence in the medium term. A larger fiscal deficit in the short run would facilitate productive invest-

As Per the Budget 2009-10 (interim) (February 2009)

greatly facilitated by fiscal and

2008-09 2009-10 Target for (RE) (BE) 2010-11 2011-12 monetary policy coordination

vulsions and the imperatives

of making the growth process much more egalitarian and inclusive have exposed the inadvisability of pursuing a rigid regime of fiscal prudence envisaged in the Fiscal Responsibility and Budget Management (FRBM) Act 2003. The entire structure and the character of fiscal prudence pursued so far calls for a rethink on the part of the authorities. A number of beneficial claims attributable to such restrictive fiscal policy can only be accepted with important caveats. For instance, it is said that reductions in gross fiscal deficit to GDP ratios have helped to provide a larger space for improved private sector investment and hence higher growth. On the face of it, it may appear to be true but the resultant constraints on public expenditures have evidently resulted in major weaknesses in the economic system in the form of the neglect of most essential expenditures on social and physical infrastructure and these lacunae have dented the roots of future growth.

The Planning Commission in its Eleventh Five-Year Plan 2007-2012 document candidly admits that “(the) poor quality of infrastructure seriously limits India’s growth potential in the medium term and the Eleventh Plan outlines a comprehensive strategy for development of both rural and urban infrastructure, defined to include electric power, roads, railways, ports, airports, telecommunications, irrigation, drinking water, sanitation, storage, and warehousing. The total investment in these areas was around 5% of GDP in 2006-07 and the Eleventh Plan aims at increasing this to about 9% of GDP by the

september 5, 2009

for certain indicators of social development I nterestingly, d espite bu dgetary r hetoric of deficit, have resulted in neglect of the most
in health, education and gender equality. “creating a competitive , progressive and essential of expenditures for social and
These targets are not identical to the Millenwell-regulated educatio n system of global physical infrastructure. Apart from ensur
nium Development Goals (MDGs) but it is bestandards that meets th e aspirat ion of all ing that fiscal policy plays a stabilising role
lieved that if these targets are met, then the segments of the societ y”, the in crease in in the economy as it passes through busi
other MDGs are also likely to be achieved. It is a matter of deep concern that at the curbudgetary allocation for elementary educa ness cycles with a counter-cyclical stance,
rent pace of progress, it appears unlikely tion during 2009-10 ov er the rev ised esti it has to aim at strong developmental and
that many of these targets will be met. mates of 2008-09 has b een less th an 1% or social roles as a rolling strategy in the
around 7% over that o f 2007-08. Experi m edium term.
The reasons are obvious, for public expenditure earmarked for specified social ence shows that state bto compensate for the l ower grow udgets are unlikely th in ex 3 An Agenda for
programmes has drastically lagged behind penditures of the cent ral gover nment in a New Fiscal Strategy
the targets. To cite two broad goals, there is these years. In this respe ct, a detailed study Perceived in the above light, there are a
a commitment made by the United Progresby Ravi Duggal (2009) in respe ct of the number of solutions which suggest them
sive Alliance (UPA) government in its previhealth sector expenditu re appears typical selves in the current situation where we
ous stint that it would increase public exof the social sector expen ditures in general: have the highest ever revenue deficit, the
penditure on education to 6% of GDP and The centre’s attempt to i ncrease sp ending on highest primary deficit in India’s post-re
that on health to 3% of GDP. In contrast, as public health by hiking allocation s to its Na form period, and the elevated levels of the
shown in Table 3, there have occurred tional Rural Health Mis sion progr amme has combined gross fiscal deficit of the central
hardly any noticeable improvements in the failed because the state s have res ponded by and state governments (RBI 2009). Such a
actual ratios in respect of e ducation and reducing their expendi ture. Inste on health, the cen ead of de deterioration on the deficit front cannot
health during the last several years; they centralising expenditurtre has taken control of a large r share of be resolved in a year or two; it calls for a
have, by and large, stagnated at around r esources for the sector, which hav e not been medium-term fiscal strategy in which
one-half of the targets for each –3% of GDP adequately utilised eve n for the pr iority pro modulations of public expenditure have to
for education and 1.4% for health. grammes (p 14). be accompanied by a determined and pro-
And now the provisions made in the To sum up, the lesso ns of the past dec gressive system of resource mobilisation.
l atest budget, even though they pertain ade or so have shown Table 3: Social Services Expenditure (Centre and State Governments Combined) Items 2003-04 2004-05 2005-06 2006-07 that just 2007-08 targeting 2008-09 3.1 Raising the Marginal Tax Rate The artefacts of India’s personal tax struc
Actual Actual Actual Actual Total expenditure (Rs crore) 7,96,384 8,69,757 9,59,855 11,09,174 Expenditure on social services 1,53,454 1,72,812 2,02,672 2,39,340 of which RE 13,55,831 3,03,490 BE 14,85,536 3,57,381 ture bring out certain glaring revelations. First, India has emerged generally as the lowest taxed nation insofar as the middle
(i) Education 75,607 84,111 96,365 1,14,744 1,35,679 1,60,642 and higher income brackets are con-

The Tenth Plan specifies monitorable targets

(ii) Health 34,066 37,535 45,428 52,126 66,423 75,055
(iii) Others 43,781 51,166 60,879 72,470 1,01,388 1,21,684
As percentage of GDP
Total expendirute 28.91 27.62 26.76 26.86 28.7 27.91
Expenditure on social services 5.57 5.49 5.65 5.8 6.43 6.72
of which
(i) Education 2.74 2.67 2.69 2.78 2.87 3.02
(ii) Health 1.24 1.19 1.27 1.26 1.41 1.41
(iii) Others 1.59 1.62 1.7 1.76 2.15 2.29
As percentage of total expenditure
Expenditure on social services 19.3 19.9 21.1 21.6 22.4 24.1

cerned. For instance, the average incidence of income tax on assesses having incomes of over Rs 10 lakh has dropped from 45.3% in 1990-91 to 21.4% in 19992000; these data are available up to the assessment year 1999-2000 only. Such declines have occurred for all income classes (Table 5, p 50). The steep turnaround took place around the income year 1997-98

of which

when the marginal tax rate was dropped

(i) Education 9.5 9.7 10 10.3 10 10.8

from 40% to 30%. In fact, tax rate changes

(ii) Health 4.3 4.3 4.7 4.7 4.9 5.1

effected in recent years do suggest that the

(iii) Others 5.5 5.9 6.3 6.5 7.5 8.2 As percentage of social services expenditure

incidence would have further come down

  • (i) Education 49.3 48.7 47.5 47.9 44.7 44.9 in the last eight to nine years. The mar
  • (ii) Health 22.2 21.7 22.4 21.8 21.9 21
  • ginal tax rate of 30% has been contrary to

    (iii) Others 28.5 29.6 30 30.3 33.4 34

    the recommendation of the Chelliah Com-

    Source: Budget Documents of the Union and State Governments, RBI (Economic Survey 2008-09, pp 267).

    mittee Report (GoI 1991-93) which had only to the central government, do not in-deficit indicators without setting out suggested a simple three-tier personal spire any confidence that there will be any a ppropriate goals for the composition of i ncome tax structure with a top rate of significant improvement during the third expenditure and nature of revenue collec-40% (Acharya 2005). It is not our intenyear of the Eleventh Plan (2009-10) in the tions, can distort the end result. It is tion to suggest introduction of an upward aggregate expenditures of the central and known how focusing on the end products, revision now when the income earners are state governments (see Table 4, p 50). namely, the gross fiscal deficit and revenue facing erosion in incomes due to the

    Economic & Political Weekly

    September 5, 2009 vol xliv no 36

    Table 4: The Budgetary Allocation for Education and Health– Central Government (Rs crore)

    A study on inter-class inequality in India

    2008-09 2007-08

    2009-10 2008-09 by an MIT team (Abhijit Banerjee 2001a, b)

    Budget Revised Budget Revised

    (1) (2) (3) (4) (5)

    concludes that the gradual liberalisation

    Health and family welfare 22,641 18,476 17,123 14,974 [14,410]

    (0.39) (0.35) (0.32) (0.32) (0.31) of the Indian economy did make it possible 1.1health 1,836 2,164 1,297 for the rich (the top 1%) to substantially

    Public 1,985

    1.2 Hospital & dispensaries 845 496 335 315 increase their share of total income.

    1.3 Medical education, training and research 3,256 2,125 1,659 1,468

    Concretely, as shown in Table 6 (p 51), be

    1.4 Prevention of food adulteration 17 15 15 6

    tween 1990-91 and 1999-2000, the

    1.5 Rural family welfare 2,335 2,228 2,336 1,947

    number of assessees in the Rs 2 lakh to

    1.6 Urban family welfare 157 158 155 129

    Rs 5 lakh income bracket increased by

    1.7 Child health and immunisation 1,591 1,372 1,777 1,351

    nearly 11 times, those in the Rs 5 lakh to

    Education 44,528 37,367 [27,185]

    38,703 29,589

    (0.76) (0.70) (0.73) (0.63) Rs

    (0.38) 10 lakh bracket jumped 33 times and

    education 19,489

    2.1 Elementary 19,683 19,778 18,440 those in the over Rs 10 lakh bracket
    2.2 Adult education 410 186 408 228

    Table 5: Average Incidence of Income Tax on Different

    2.3 Secondary education 6,470 4,057 5,140 2,465

    Income Classes

    2.4 Technical education 5,415 4,189 3,963 2,002

    Tax Payable as Percentage of Income of Returns GDP at current market prices 58,56,589 53,21,753 53,21,753 47,23,400 Year 2 Lakh to 5 Lakh 5 Lakh to 10 Lakh Over 10 Lakh Figures in round brackets are percentages to GDP at current market prices. 1990-91 40.9 46.6 45.3

    Figures in square brackets are actuals. GDP for 2009-10 is estimated at 10.05% annual growth as in the Budget Documents.

    1991-92 39.8 43.0 45.0 Source: GOI (2006): Budget Documents, Expenditure Budget, Volume 2.

    1992-93 39.8 49.6 44.9

    1993-94 40.6 51.0 47.8 c urrent recession. It should nevertheless factually. Better buoyancy has come about 1994-95 31.3 30.5 45.5 constitute a part of the medium-term because there has occurred a sharp rise in 1995-96 28.2 30.5 28.0 fiscal strategy. the number of persons earning high incomes, 1996-97 28.2 30.5 28.0 Secondly, the authorities have claimed and also quite a large number of them

    1997-98 28.6 31.4 28.2

    1998-99 19.3 22.7 20.2

    that reductions in tax rates have resulted in the financial sector and in executive

    1999-2000 18.1 20.7 21.4

    in better compliance and improved tax categories where tax avoidance or evasion

    Source: MoF (2005): Indian Public Finance Statistics 2004-05,buoyancy – a claim which is not proven becomes difficult. p 86, Economic Division, September.


    Table 6: Income Tax Revenue Statistics – Size Distributionthe growth of real GDP

    Assessment Year

    originating from non-

    Range of Income (Rs) 1990-91 1994-95 1999-2000 1999-2000 Number as of agricultural sectors which

    Multiple of 1990-91

    was followed by a similar

    (a) Number of returns

    improvement in direct

    2,00,001-5,00,000 34,357 76,392 3,73,129 10.9

    tax revenue as percent

    5,00,001-10,00,000 2,292 9,539 76,663 33.4

    Over 10,00,000 1,564 5,543 78,109 49.9 age of non-agricultural
    Total 38,213 91,474 5,27,901 13.8 GDP. Between 2003-04
    (b) Income of returns (Rs Lakh) and 2006-07 (assessment
    2,00,001-5,00,000 1,00,854 2,27,627 9,69,231 9.6 years), the number of in
    5,00,001-10,00,000 15,734 1,35,147 5,02,415 31.9 dividual income tax as-
    Over 10,00,000 37,602 2,20,156 11,42,460 30.4 sessees has shown a small
    Total 1,54,190 5,82,930 26,14,106 17.0 increase from 26.62 mil
    (c) Tax payable (Rs Lakh) lion in 2003-04 to 27.68
    2,00,001-5,00,000 5,00,001-10,00,000 Over 10,00,000 41,199 7,326 17,030 71,197 41,287 1,00,222 1,75,187 1,03,908 2,44,123 4.3 14.2 14.3 million in 2006-07. This was the period when
    Total 65,555 2,12,706 5,23,218 8.0 sharp increases in in-

    Source: See Table 5. comes of company execu

    tives as well as increases jumped 50-fold. The extent of inequity in in capital market operations had taken the income tax structure is evident from place (EPWRF 2008 and Shetty 2008). In the differential multiples of increases in brief, there is thus reason to believe that it i ncomes assessed and those in taxes paid is the shift of incomes in favour of richer by the high-income classes of Rs 5 lakh to classes in the period of high growth that Rs 10 lakh and above Rs 10 lakh income has been mainly responsible for improved brackets. These categories had increases buoyancy in direct taxes, crudely reprein assessed incomes by 30 to 32 times sented here by the rise in tax to non-agribut their taxes payable increased by only cultural GDP ratio. Yet, the draft tax code 14 times between 1990-91 to 1999-2000 released in August 2009 proposes a fur(Table 6). ther reduction in tax rates in different

    As shown in Table 5, the significant re-slabs from 2011-12 albeit with a narrowing ductions in the average incidence for high-of exemption. It is more than likely that income brackets began in the middle of while the rates will be reduced the exempthe 1990s, with a steep reduction in the tions will be retained, thus further widenbudget of 1997-98. But, the improvement ing inequality. in buoyancy of direct taxes had not begun for the next decade or so, at any rate not 3.2 Capital Gains and

    Dividend Taxes

    A blatantly regressive aspect of the person12al tax structure in the country relates to abolition of taxes on capital gains in equity


    and dividend earnings. These have been


    severally criticised by many public finance specialists such as Bagchi (2002), Raja


    Chelliah (2002) and Acharya (2003). One statement by Acharya (2005) brings out


    the severity of criticism in this respect:


    The current exclusion of both dividends and

    1990-91 1993-94 1996-97 1999-2000 2002-03 2005-06 2008-09

    long-term capital gains on security transacuntil the year 2003-04. Chart A depicts tions from the base of personal income tax is the real rates of growth in non-agricultural hard to justify in a poor country, straining to

    GDP and juxtaposes it against the ratio of

    increase tax revenues. The contrast between taxation of labour incomes and exemption of

    the central government’s direct tax reve

    returns from equity capital is stark. Some re

    nue to non-agricultural GDP (in nominal

    form is in order, but it has to be carefully terms). The period between 2003-04 and calibrated to minimise market disruptions 2008-09 has seen steady increases in (p 2069).

    Economic & Political Weekly

    September 5, 2009 vol xliv no 36

    Chart A: Real Growth of Non-Agriculture (NA) GDP and Direct Tax to NA GDP Ratio (in %)

    NA GDP growth (real) Direct tax to NA GDP ratio (Nominal)

    The introduction of new tax measures such as the fringe benefit tax (FBT), security transactions tax (STT) and the commodity transactions tax (CTT), have the same egalitarian objective by mopping up unearned incomes. Hence, the abolition of FBI and CTT in the latest budget appears to be highly unreasonable and inadvisable.

    3.3 Disinvestment in PSUs

    With a careful calibration, there is scope for generating revenues through partial sales of government equities held in public sector undertakings (PSUs). But, as per past practice, the resources so mobilised should not be used for expanding budgetary resources. Instead, they should be deposited as part of a corpus for financing special social expenditure schemes beyond the budgeted programmes, for which there is ample scope. In this regard, the decision taken in 2000-01 to employ the receipts from disinvestment (and privatisation) for meeting expenditure on social sectors, restructuring of central public sector undertakings (CPSUs) and for retiring public debt, appears a valid one. However, the National Investment Fund scheme, instituted in November 2005, was somewhat restrictive, in that the corpus so created would be of a permanent nature and only the annual income earned on the corpus is to be used for social expenditures and capital investment in PSUs in the ratio of 3:1. Instead, the funds accumulated in the corpus deserve to be released after a lapse of every five years or so for utilisation in social and physical infrastructure programmes in the public sector, as also for long-term financing requirements of large-sized investment projects in the private or public sector or even those operating in the form of public-private partnerships. In fact, this source of funds may be used to fill the vacuum created in the absence of development finance institutions (DFIs) in the country for offering project finance, the details of which may have to be worked out.

    3.4 Monetisation of Borrowings

    As the RBI has shown, the net draft on the market resources through central and state government borrowings has been unprecedented. Such combined net market borrowings during 2008-09 were nearly two and a half times their net borrowings

    Table 7: Borrowings of the Central and State Governments: 2009-10 (Rs crore)
    2009-10 2008-09 2007-08
    Item Interim Budget Budget % Increase in BE Actual Actual
    Estimates Estimates (BE) over 2008-09
    Central government
    Gross market borrowings $ 3,98,552 4,91,044 54.2 3,18,550 1,88,215
    Net market borrowings 3,08,647 3,97,957 33.3 2,98,536 1,08,998
    State governments
    Net market borrowings 1,26,000* 1,40,000* 34.9 1,03,766 56,224
    Total net market borrowings 4,34,647 5,37,957 33.7 4,02,302 1,65,222

    $ Pertain to dated securities and 364-Day Treasury Bills.

    * Estimated. The state governments have been allowed to borrow an additional 0.5% of gross state domestic product (GSDP) as part of the fiscal stimulus package in 2008-09 and another 0.5% of GSDP in the Union Budget 2009-10, raising their budgeted borrowings in 2009-10 to 4% of GSDP. Source: Reserve Bank of India, First Quarter Review of Monetary Policy 2009-10.

    during 2007-08, and now, their budgets for 2009-10 have placed such borrowings higher by as much as 34% over those in 2008-09 (Table 7).

    Insofar as the central government borrowings are concerned, the revised borrowing calendar envisages that net borrowings of Rs 2,65,911 crore, or two-thirds of the annual budget of Rs 3,97,957 crore, will be completed during the first half of 2009-10 (April-September). The RBI has agreed to purchase government securities under its open market operations (OMOs) for an indicative amount of Rs 80,000 crore during the first half of the current fiscal year. Both the RBI and the government are wedded to the FRBM regulations and hence are extremely reluctant to use the term “monetisation” in the context of the RBI’s special OMOs created essentially for facilitating the unprecedented levels of government borrowing programmes. As argued in a recent note, the situation would call for “considerable monetary easing if the increase in yield rates is to be contained within moderate limits” (EPWRF 2009).

    However, there is also merit in the argument that the RBI may preserve the monetary weapons in its armoury for use when growth picks up and the commercial credit expansion entails further monetary easing. For the extraordinary government borrowing programme, it is necessary to deploy the facility of an exceptional character available in the FRBM regulations, that is, in the form of direct monetisation of government borrowings by the RBI for such exigencies. If a threefold rise in net market borrowings within a period of two years by the central and state governments – from Rs 1,65,222 crore in 2007-08 to Rs 5,37,957 crore in 2009-10 – is not an extraordinary situation, what else will be?

    Also, the reliance on OMOs alone for injecting liquidity has a serious flaw in that it would provide the unnecessary leeway for the market to push up yield rates on government securities, thus increasing the total interest burden for the budget. The experience of conducting OMOs in July and early August 2009 when the RBI has had to reject OMO bids shows the difficulties ahead in using OMOs as a weapon to smoothen the market for intensified government borrowings. As against a planned OMO borrowing of Rs 13,500 crore in July 2009, the RBI could achieve only Rs 5,251 crore because of excessive yield demands by the market. In early August all the bids obtained for the Rs 12,000 crore worth loan floatations had to be rejected for the same reason. It is significant that despite there being a massive amount of excessive liquidity in the system, the central as well as state government borrowings have been conducted at substantially higher yield rates than in the previous year.

    3.4 An Inadvisable Move

    Finally, the reported enthusiasm on the part of the Union Finance Ministry to e stablish a Debt Management Office (DMO) in the government so as to achieve separation of monetary and debt management functions, is somewhat misplaced, particularly in the current context of the RBI having to support the government borrowing programme to an unusual extent which may persist for the next two to three years. As it is, the RBI has been exercising its operational independence within the given socio-economic constraints. The notion of the functional separation b etween monetary and fiscal policies itself arises from the conventional monetarist stance of inflation control by monetary policy. In India, inflation is primarily

    september 5, 2009

    d etermined by supply factors and also by many social influences of income distribution, etc. Even the generation of money balances is influenced by real growth factors except during the past few years when external capital flows have generated explosive growth of domestic liquidity for which, again, close coordination was possible between the government and the RBI to achieve an innovative sterilisation arrangement within the current dispensation, or what Dr Y V Reddy (2009) called “ the nature of creative tensions, with a notable beneficial impact on the economy” (emphasis added).


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    vol xliv no 36

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