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Mainstream, VOL L, No 15, March 31, 2012

India’s Public Debt Explosion: Heading Towards Bankruptcy

Monday 2 April 2012, by B P Mathur


The huge public debt the Western countries have accumulated, has created an economic crisis and threatens their standard of living. Daniel Gross, the economic editor of Yahoo Finance, writing in Newsweek (Special Issue 2011) says: ‘Until now power has been defined largely by military strength, by control over vital resources like oil, but in coming years, ability to manage debt may be the best indicator where global economic power resides. Threats to sovereignty now come not from domestic insurgents but from international investors.’ The foremost agenda before the governments in these countries is freedom from crippling debt and restoring fiscal balance.

In India, the government is financing its massive public expenditure by resort to heavy borrowing, but it believes that its debt is within the sustainable level and there is no chance of the country getting caught in a debt trap which may derail the economy. This position bears a close scrutiny. The following table gives the details in this regard:

During five years from 2007-08 to 2011-12, the expenditure of the government increased by 76 per cent, at an average growth of 15 per cent annually, but borrowing jumped by 225 per cent, an annual growth at 45 per cent. There was a sudden increase in expenditure as well as borrowing in the Revised Budget of 2008-09, when expenditure jumped by 25 per cent and was met wholly by resorting to additional borrowing which increased by 250 per cent over the original Budget estimates. On February 29, 2008, the Finance Minster, while presenting the Budget for 2008-09, had observed: “It is widely acknowledged that the fiscal position of the country has improved tremendously. I am happy to report that the revenue deficit for the current year will be 1.4 per cent (against a BE of 1.5 per cent) and the fiscal deficit will be 3.1 per cent (against a BE of 3.3 per cent). Further progress will be made in 2008-09.” The global economic recession had started in 2007 and was at its peak in 2008, but fortunately India was not severely impacted by it. It was therefore surprising how the UPA-I Government suddenly changed its stance and went for massive additional expenditure in the Revised Budget of 2008-09, ostensibly on the ground that it was meant to fight the recession. One cannot help concluding that it was a political decision with an eye on the election, and many populist schemes were launched with heavy expenditure liability (the election took place in the first-half of 2009). Having once launched populist schemes, it is practically impo-ssible to withdraw them, and the government is now continuing them, with heavy expenditure and debt liability year after year.

As matters stand today, on an average every rupee that the government spends, 35 paisa comes from borrowing. Two-thirds of these borrowed funds are used up by the current consumption and only one-third is spent on capital expenditure. It is the first principle of public finance, written in every economics textbook, that money should be borrowed only for productive investment so that it can generate a future stream of income to pay back the borrowed funds.

The government can incur massive additional expenditure only if it can raise commensurate revenue through taxation. But if expenditure is financed by incurring debt liability, it can have disastrous consequences for the economy, besides imposing heavy interest payment liability. The following table indicates the extent to which current revenue earnings have to be earmarked to pay as debt-servicing charges.

At present on an average, 35 per cent of the government’s revenue goes to pay for interest charges on past debt and thus only 65 per cent of all revenue garnered is available to meet the entire expenditure liability of the government. One can understand the serious constraints from which the government’s fiscal management suffers.

Measuring Deficit as Percentage of GDP: Half-truth

ECONOMISTS measure the state of the nation’s finances in terms of budgetary deficit as a percentage of the GDP. This camouflages the real health of an economy, as it becomes a statistical jumble of certain percentage in fraction points, and hardly makes sense to the common man if it rises from 2.7 per cent to 6.4 per cent. The GDP is basically a measure of a country’s overall economic output—the market value of all final goods and services made within the borders of a country in a year. Economists use the GDP to measure the productivity of an economy, as that is an indicator of capacity to pay, in terms of taxes and duty which the state can levy. If the economy is growing, it has a better capacity to pay taxes. But in a country like India, where there is huge black economy and widespread tax evasion, without commensurate cyclical growth in revenues, measuring deficit as a percentage of the GDP gives a totally inadequate idea of the full dimension of the problem. India also suffers from a poor statistical database, due to which the figures of the GDP computed by the Central Statistical Office are not very reliable. For example, at the time of presentation of the Budget of 2010-11 (February 2010) the GDP was computed at 69.35 lakh crores, but in February 2011, the CSO revised the figure to Rs 78.78 lakh crores (a 20 per cent growth over previous year in nominal terms, as compared to 12.5 per cent reckoned earlier). This resulted in substantial lowering of the figure of fiscal and revenue deficits of 2010-11.
Fiscal Discipline: Half-hearted Approach

IN order to rein in the deficit, which the government had been incurring for many years, a Fiscal Responsibility and Budget Management Act was enacted in 2003, after years of prevarica-tion. The Act had originally mandated that the revenue deficit should be eliminated, and the fiscal deficit should not be more than three per cent of the GDP by March 2008. Later in 2004, the target was shifted to March 2009. For the first few years of the FRBM Act, the government made prudent management of finances and by 2007-08, the revenue deficit declined to 1.11 per cent and fiscal deficit by 2.69 per cent. However, from 2008-09, the government has thrown fiscal caution to the wind and is incurring massive deficits. The following table illustrates the point:

Besides the Central Government, the State governments are also financing their expenditure through borrowing. The average fiscal deficit of State to State GDP is around three per cent and the revenue deficit ranges between 0.5 to one per cent. Thus the combined fiscal deficit of the Centre and States is running close to nine per cent of the GDP for the last three years, while the revenue deficit is between four to five per cent. The 13th Finance Commission (November 2009), had expressed concern about the deficit of the government, both Central and the States. It noted that the debt of the Central Government was of the order of 60.07 per cent of the GDP and States 35.28 per cent (debt relative to GSDP) for 2007-08. The Commission estimated that the combined debt of the Centre and States at 78.8 per cent of the GDP in 2009-10, with the Centre’s share at 54.2 per cent and the States at 29.6 per cent. It recommended a fiscal consolidation path under which the consolidated debt of the Centre and States should come down to 68 per cent of the GDP—the Centre’s at 45 per cent and States’ to below 25 per cent by 2014-15. The Commission also suggested that the revenue deficit of the Centre should be reduced and completely eliminated by 2014-15.

Today we are nowhere near the fiscal consolidation path suggested by the 13th FC. The Ministry of Finance is playing down the severity of the problem of the mounting debt burden. The Ministry has brought out a Status Paper on Debt in November 2010, which says that the sustainability of debt need not be judged in the traditional classical tool, and observes: “Some of the important parameters for determining the stability and vulnerability level of public debt, for example, could be the maturity profile, composition, carrying cost, external or domestic investor base along with savings rate, potential and realised tax to GDP ratio etc.” In support it says that out of the overall Central Government debt, 92 per cent is internal and only eight per cent is external. Most of the market loan is in the form of dated securities, with weighted average maturity of 10 years and interest rate of 7.8 per cent. The Committee concludes that India has less risk parameter than many other countries. While India may not face the risk of debt-default, the adverse consequences of mounting debt should not be underestimated. The Finance Ministry is also playing with the figures of debt stock in order to give an impression that the problem is not acute. According to the Budget papers, the total internal debt and other liabilities of the Central Government was Rs 39.30 lakh crores (Internal Debt Rs 37.74 lakh crores and External Debt Rs 1.56 lakh crores) as on March 2011. This works out to 50 per cent of the GDP. However, while presenting the statement under the FRMB Act (February 2011), the total outstanding liabilities for 2010-11 have been reckoned as 45.3 per cent of the GDP, as the component of the NSSF invested in State Government securities and the debt raised under the Market Stabilisation Scheme has been excluded. Such statistical juggleries are not going to minimise the problem of debt burden.

Porous Tax Regime

FROM ancient times, tax is the main source of revenue of governments all over the world. If the tax revenue is not showing buoyancy and keeping pace with the growth of expenditure, it will inevitably lead to deficit in government Budgets. During the last five years the percentage of tax-revenue to total expenditure of the government (including capital) has come down from 60 per cent to 46 per cent aggravating the problem of budgetary deficit, as the following table indicates.

The amount of revenue raised is determined by the tax base and tax rate. Due to a range of measures—such as special tax rates, exemptions, deductions, rebates etc.—a huge amount of revenue is foregone. The Revenue Budget gives a statement of the revenue foregone due to various exemptions and concessions. The details for the last four years in respect of corporate tax, excise and customs is given in the table below which shows that there is considerable scope for collecting more taxes, both direct and indirect.

Presently the effective tax rates for companies work out to only 23 per cent. Corporates are known to avoid taxes by using smart accounting practices. Indian corporates are making huge profits, and there is a case for withdrawing some of the exemptions given to them to garner more revenue. Some of the concessions given in customs duty on gold, fruits, vegetables and edible oil are totally unjustified and need to be withdrawn. A huge amount of tax revenue—Rs 93,600 crores (March 2010)—is locked up in tax disputes and another Rs 51,300 crores, though not under dispute, the Tax Department is unable to recover.
In case of personal Income Tax, the bulk of the tax is collected from salaried employees, where tax is deducted by the employer at source. Persons with huge income, who are in business, industry or in the self-employed category, evade or escape bulk of the tax. Over the years economic inequality in our society is increasing. The UNDP Human Development Report notes that the richest 10 per cent enjoy a disproportionate, 37 per cent share of the national income. According to Forbes, India has 69 dollar billionaires with a combined net worth of 100 richest Indians equal to $ 300 billion, a quarter of the country’s GDP. A good tax system following the principle of equity should be able to mop up ‘mountains of income earned by the rich, due to the free play of the market forces’ in our capitalist-oriented economy, and put it to socially productive uses. Our tax system has completely failed in this regard.

India’s tax revenue is only 10 per cent of the GDP. Most developed countries such as Australia, France, Italy, Netherlands have over 20 per cent tax-GDP ratio. the UK’s tax revenue as percentage of the GDP is more than 25 and Nordic countries, such as Denmark and Norway, have more than 30 per cent tax-GDP ratio. It is a well-known dictum that tax administration is tax policy. Low tax recovery reflects a weak administration with large-scale tax avoidance and evasion. A low tax-GDP ratio also reflects sizeable parallel economy with unrecorded and undisclosed income. The vast parallel black economy that we have, results in a huge loss of tax revenue. The government does not possess a strong will to take tough measures to collect more taxes. Gunnar Myrdal had described India as a ‘soft state’, unwilling to take hard and tough measures to implement law. This aspect of the soft state is most visible in the case of tax administration, where due to low tax collection, the entire economy is in jeopardy.

Desperate for money, the government is selling the shares of Public Sector Undertakings (PSUs) to raise resources. In 2009-10, the PSUs’ share of sales earned Rs 24,581 crores and in 2010-11, Rs 22,744 crores. Shares were sold of some of the prized companies such as the NTPC, REC, Coal India, SCI, Engineers India, Power Grid Corporation etc. It is pointless to sell the shares of profitable PSUs, if their status is to be maintained as government company (the government retaining more than 50 per cent equity). It tantamounts to selling the family silver to pay for the grocer’s bill. The PSUs are one bright spot in the economic scenario. The PSUs (including banks and financial institutions) have contributed to the national exchequer Rs 50,428 crores in 2009-10 and Rs 48,726 crores in 2010-11, by way of dividend and surplus.

Unproductive Public Expenditure

UNFORTUNATELY in India, there is no realisation of the gravity of the problem which the massive debt-financed public expenditure is causing, as Budget-making has been surrendered to political expediency, rather than to fiscal prudence. Follo-wing the Keynesian revolution, economists have been giving intellectual fodder for a philosophy of budgetary deficit for economic development. Economist Martin Feldstein observes: “It is unfortunate therefore that, starting with the 1940s, economists developed a series of different arguments that encouraged the political process to accept larger and larger peacetime deficits. These analyses started with simple Keynesian arguments and were followed by new theories of economic growth, theories of household saving behaviour, and models of the global capital markets. The arguments were intellectually quite different from each other but they all lead to the same conclusion: that budget deficits in peacetime were not a problem for the economy.” Politicians are quick to seize an economic ideology which allows higher levels of government spending and lower levels of taxation. Deficits shift the fiscal cost to future generations that are not yet voters. Deficits impose burdens on the economy that, unlike the very tangible benefits of more spending and lower taxes, are not directly visible to the current voters.

Massive Expenditure—Plan Schemes in Social Sector

A large chunk of public funds are not optimally used and utilised in unproductive activities which do not generate growth in the economy. From the beginning of the 11th Plan (2007-08), the government has greatly enhanced the expen-diture on plan schemes in the social sector, without giving any regard to the availability of resources to meet the additional outlay. In the first year of the Plan 2007-08, the Central Government’s budgetary allocation was Rs 2,07,500 crores, but by the fifth year 2011-12, the allocation has been more than doubled to Rs 4,41,500 crores, with an annual growth of expenditure of more than 40 per cent. Only about 20 per cent of Plan funds are being used for capital outlay and the bulk of the money is used for revenue expenditure. The bulk of the additional allocations is in social sectors in what are known as flagship programmes, and operated as Centrally Sponsored Schemes (CSS). The huge money spent on these programmes from the Central Budget alone can be judged from the money allotted in seven flagship programmes in 2011-12 (BE): National Rural Employment Guarantee Scheme (MGNREGS): Rs 40,000 crores; National Rural Health Mission (NRHM): Rs 16,140 crores; Sarva Shiksha Abhiyan (SSA): Rs 12,000 crores; Mid-day Meal: Rs 6500 crores; Grameen Sarak Yojna (PMGSY): Rs 18,200 crores; Avas Yojana (IAY): Rs 9000 crores; and Rural Electrification (RGGVY): Rs 5300 crores.

The practical working of the Centrally Sponsored Schemes (CSS) is extremely complicated and defies logic. Presently there are as many as 147 CSS, with varying size, objective and formulae for expenditure sharing between the Centre and States. In some schemes such as universal education (SSA), the cost is shared between the Centre and States in the ratio of 65:35; while in the housing scheme, IAY, in the proportion of 75:25. The scheme of rural roads, PMGSY, is fully funded by the Central Government. The State governments have been raising concern about the lack of flexibility in the CSS, adverse impli-cations of counterpart funding and questionable utility of operating a large number of schemes with thinly spread resources at the field level. In recent years there has been a major shift in the Central Government’s policy for implementing the CSS. The Union Government has now started transferring Central Plan assistance directly to the State/district level autonomous bodies, societies, non-government organisations for implementation, outside the State Budget. During 2009-10, the Central Government transferred a sum of Rs 93,880 crores directly to the State-level autonomous bodies etc., which constituted 33 per cent of the Plan expenditure of Rs 3,03,600 crores. Unlike government departments, the funds transferred to these organi-sations are allowed to be retained by them at the end of the financial year and do not lapse. Thus it is difficult to know if the money given to them was utilised. The money, so transferred, is not subject to automatic audit of the CAG and no sound arrangement for auditing them exists. The CAG has raised serious concern about the inadequacy of the existing arrangement. A system without a built-in financial accountability framework is subject to misuse.

The performance audit conducted by the CAG, the social audit conducted by NGOs and numerous studies by experts show that there is huge wastage and leakage of funds in the CSS. Numerous lapses have been noticed in the Rural Employment Guarantee Scheme, on which a colossal sum of Rs 40,000 crores is being spent annually, and the benefit of the programme is not reaching the beneficiaries. The objective of the MGNREGA is to enhance the livelihood security of people in the rural areas by guaran-teeing 100 days of wage employment in a financial year to a rural household whose members volunteer to do unskilled work. While the MGNERGA has been able to reduce distress migration to some extent and helped improve-ment in the bargaining power of agriculture labour, it has huge spin-off effect. The MNREGA is simply a dole given to rural labour—it has created a huge shortage of labour for agriculture farming during the sowing and harvesting season, making agriculture an even more ‘un-remunerative’ occupation. It is also encouraging ‘idleness’ among labourers, as they get wages by simply signing on the muster role. The Chairman of the Krishak Sangh, Ajay Jhakar, is highly critical of the scheme and observes that it is a policy designed by a utopian non-existence system, and feels that if 100 days employment was guaranteed in the lean agricultural season, it might have created some positive outcomes. (The Hindu, February 2, 2012) Even the Planning Commission recognises that the MNREGA is not a long-term solution to rural poverty, which can be reduced only by shifting from low productivity employment in farming to higher productivity employment elsewhere. Experts feel that instead of doling out huge money, investment should have been made in increasing rural prosperity and productivity which would have created the employment opportunity.

It is the same story with programmes of rural health and primary education. The National Rural Health Mission in UP has become a national shame. Some honest doctors who wanted to control corruption were murdered by the unscrupulous mafia and the cases are now under the CBI probe and the working of the scheme is being investigated by the CAG. The objective of universal literacy for children is nowhere near fulfilment, though the Constitution had envisaged full literacy within ten years of its coming into being. The biggest problem with primary education is poor quality of learning, high drop-out rates, teacher absenteeism, large-scale vacancies of teachers and inadequate teaching aids. A survey by the NGO, Pratham, presents an alarming picture: every second child in class 5 can’t read a class 2 text; three out of five can’t solve simple divisions after five years of schooling; 50 per cent children are at a level lower than what is expected after two years in school. These problems cannot be resolved simply by pouring money into education or enacting a Right to Education legislation.

Most of the programmes in the area of poverty alleviation, education and health suffer from faulty designing and poor implementation. They are implemented through the DRDO (District Rural Development Agency), BDO (Block Development Officers) and other petty officials of the State’s sprawling bureaucracy, who are spread over the districts, tehsils and villages, and are at the cutting edge of contact with the ‘poor’. They are inefficient and corrupt and siphon off most of the public funds. The public, who come in contact with the lower echelons of the administration, are fully aware of the ineptitude of the system. It was for this reason that there was a countrywide upsurge when Anna Hazare launched his campaign against corruption. Our planners and policy-makers should realise that the existing administrative system calls for a complete overhaul and major reforms before it can deliver results.

India started planned development in the 1950s. We are now towards the end of the 11th Plan. It is therefore pertinent to ask as to why, 65 years after independence, the country has not been able to make any significant dent into its gigantic problem of poverty, unemployment, illiteracy and provision of rudimentary medical services. Our present economic woe is largely due to the path of economic planning charted by the Planning Commission. Although we are a federal country, the Planning Commission has usurped the functions of the State governments and does meticulous planning and micro-management of every aspect of the State’s economic activity. In areas such as agriculture, health and education, which fall within the jurisdiction of the State governments under the constitutional scheme, the States have very little leverage to plan and execute schemes as per their needs and priorities. Under the Constitution it is the responsibility of the Finance Commission to allocate funds to the States, but the Planning Commission has taken over this function for a substantial portion of funds and has become an extra-constitutional body accountable to no one. The Planning Commission has encroached into the jurisdiction of the Finance Ministry of the Government of India as well, by taking control of allocation of Plan funds and thus the Finance Ministry has no leverage to allocate money to individual Ministries and departments depending on inter se requirements and priorities. It is time we bade good-bye to centralised planning and abolished the Planning Commission. The centralised planning in erstwhile USSR, which led to its rise as a totalitarian state, was a complete failure. Our present mess of a mountain of debt and unbearable interest burden is largely due to the Planning Commission, which spends money on fancy programmes and unproductive activity, with no responsibility to raise resources to finance them.

Wasteful Expenditure: MPLADS

THE elected representatives do not feel that they should set an example of austerity; as a result a lot of wasteful public expenditure takes place. Besides their salaries, MPs and MLAs have been given liberal allowances and perks which add a significant burden on the exchequer. The most glaring case of misuse of public resources is the Member of Parliament Local Area Development Scheme (MPLADS), introduced by the Narasimha Rao Government in December 1993. Under the scheme each MP is allocated Rs 2 crores and he can select works to be implemented in his constituency (in case of Rajya Sabha members, anywhere in the State). Between 1993 and 2010-11 a sum of over Rs 23,500 crores was allocated and released towards this scheme. The Budget allocation for 2011-12 is Rs 2527 crores; thus over Rs 26,000 crores have been spent on the scheme so far. Experts have severally faulted the scheme on several counts. The National Commission to Review the Working of the Constitution (2002), headed by Justice Venkatachaliah, observed: “The MPLAD scheme is inconsistent with the spirit of federalism and distribution of powers between the Union and States. It also treads the area of local government institutions”, and recommended its discontinu-ance. Veteran parliamentarian and former Chairman of Public Accounts Committee Era Sezhiyan, in a detailed report (2005), has commented that the scheme is a blot on democratic governance and legislators, instead of the accountability mechanism, assume the role of the executive. The scheme obstructs the process of decentralisation of authority and resources towards the emergence of village level self-government. The CAG has conducted three reviews of the scheme (1998, 2001, and 2011) and pointed out huge lapses and misuse of funds. Taking cue from the Centre, almost every State has established the MLA’s fund, with a huge outgo from the Budget. The scheme is ab initio unsound and unworkable but the government is in no mood to withdraw it. A colossal sum of Rs 26,000 crores has been wasted. The unfortunate part is that it is funded through public debt, as the government is having a huge revenue deficit, and its cost will be borne by future generations.

The Wage Burden of Public Employees

THE government’s expenditure on salary and allowances of its employees has more than doubled in the last five years largely due to the Sixth Pay Commission award, though there has been only marginal increase in the number of employees on the rolls. The following table gives the details.

In 2007-08, the salary and pension bill of the employees (including defence forces) was 16 per cent of the Central Government’s revenue; in five years time (2011-2012) it has jumped to more than 25 per cent. The Sixth Pay Commission has given a huge bounty to the government servants. Besides, more than doubling the pay, it has indexed salary to inflation and every six months, the employees get a pay rise based on the rise of the cost of living index. Today the Dearness Allowance of a government servant is more than 50 per cent of his basic salary. Huge benefits—such as travel by air on LTC for employees above a certain pay band, women employees eligible for two years leave on full pay to rear children etc.—have been given. Similar bonanza has been given to pensioners—an employee on retirement can draw full pension after 20 years of service, instead of 33 years earlier; and get an escalation of 25 per cent of pension every five years on attaining the age of 80.

The figures of expenditure of civilian employees, given in the Budget document, do not reflect the full extent of the government’s salary bill, as it does not include the cost of employees of autonomous institutions such as Provident Fund Commissioner, ESIC, AIIMS, CSIR, ICAR, IIPA, who are controlled/funded by the government and enjoy the same terms and conditions of service as Central Government employees. Teachers and staff working in colleges and universities such as the JNU, DU, UGC etc. have also been given salary increases, in line with Central Government employees, which has added a huge burden on the exchequer. In addition to salary and allowances, public servants enjoy perks such as free medical treatment under the CGHS (on nominal payment), subsidised housing and staff car facility etc. The salary bill does not include the expenditure on travel, guest houses, free ration for defence personnel and many other frills enjoyed by them. The wage bill and perks of not only government employees, but those of autonomous bodies and universities have to be ultimately picked up by the government. No computation regarding the full cost of the employees funded by the government is available—but as a guesstimate, it may run up to be even 50 per cent of the revenue receipt of the government.

The position of States is more precarious. Due to competitive politics, most States have been adopting Central pay-scales, irrespective of the availability of resources. To illustrate, the percentage of expenditure on salary of employees and pension to the State’s own revenue (tax and non-tax) runs to 52 per cent in West Bengal; 56 per cent in UP; 57 per cent in Punjab; 70 per cent for Orissa; 129 per cent in Assam and 132 per cent in Bihar (estimated by the 13th FC for 2009-10). In addition to the wage bill, there is a huge committed liability of interest charges on debt incurred by them. There is no money left for education, health and other development work after meeting the liability on account of the wage bill and interest.

Can the government afford such largesse as wages for public employees? The productivity of the government employees is abysmally low in India. Besides being inefficient, a large number of employees are also corrupt. There is no accountability in the system. Several high powered Commissions—such as the Seventh Pay Commission, Expenditure Reform Commission, Second Administrative Reforms Commission—have come out with laudable suggestions to reform the public administration, but they have been stone-walled by the bureau-cracy. Reputed international organisations such as the World Bank, Transparency International etc. have time and again pointed out that the bureaucracy is standing in the way of country’s development. Recently, the Hong Kong based Political and Economic Consultancy has ranked India at the bottom of 16 Pacific-rim countries it surveyed and has said that India has the most suffocating level of bureaucracy. In the face of such poor performance, was there any justification to give such a huge reward to public servants by implementing the Sixth Pay Commission recommendations in 2008, when the country was in the grip of economic recession? The burgeoning cost of the wage bill of the public employees has made a deep hole in the pocket of both the Central and State governments. No wonder, the people say that the government exists for the benefit of the government servants alone!

Poor Outcome of Public Expenditure

ONE of the main problems with the huge expenditure incurred in our country is its poor outcome in terms of delivery of public services. The Ministry of Finance follows outdated budgetary practices, due to which optimum use of public money cannot be made by the spending departments. The administrative Ministries, departmental heads and field outfits face two major problems in efficient utilisation of money: a) the system of annual budgeting leading to lapse of money at the end of the fiscal year and rush of expenditure in the month of March to avoid lapse which results in tremendous waste of public money; b) the centralised control of the Finance Ministry and absence of delegation to administrative Ministries and field outfits, responsible for the implementation of policies, and delivery of services.
Paradoxical though it may appear, while the government is perennially short of money for its various programmes and schemes, a huge amount of money allocated in the Budget gets surrendered every year as it cannot be utilised. Civil Ministries of the Government of India (other than Defence, Railways and P&T), surrendered a sum of Rs 73,500 crores in 2009-10 (seven per cent of the overall Budget); Rs 48,000 crores (five per cent of the Budget) in 2008-09 and Rs 40,600 crores in 2007-08 (six per cent of the Budget) (data from the CAG’s Audit Report for 2010-11). The dimension of the problem can be appreciated from the fact that in three years 2007-08 to 2009-10, the money surrendered by some key Ministries was as follows: Department of School Education and Literacy: Rs 12,343 crores; Department of Higher Education: Rs 4690 crores; Department of Health and Family Welfare: Rs 3546 crs; Police: Rs 7721 crores; Ministry of Road Transport and Highways: Rs 6169 crores; Ministry of Power: Rs 3155 crores. The most alarming position was that of the Ministry of Defence, which could not use Capital Outlay of Rs 15,259 crores meant for moderni-sation of the armed forces. There are two reasons why Ministries and departments are unable to use the money. First, even when money is provided in the Budget, there are numerous procedural formalities, such as clearance of schemes by the Expenditure Finance Committee, sanction of posts etc., before it can be spent. These clearances do not come by speedily and the money lapses. Second, the tendering and contracting procedure for purchase of equipment, goods and services is long and tortuous and it takes considerable time to complete the prescribed formalities of placing orders and taking delivery of supply and services.

Most developed countries have resolved the aforesaid problems by modernising expenditure management systems and shifted to the medium-term-expenditure framework. The UK, Australia, New Zealand and Scandinavian countries have moved to multi-year budgets, with a proper linkage with annual budgets. In the UK, Firm and Fixed Departmental Expenditure Limit (DEL) plans are set for three years going forward, and those are planned and controlled on a yearly basis in biennial Spending Reviews. This enables spending programmes to be planned over medium term and allows the department to carry forward any unspent resource to future years. End-year flexibility removes the perverse incentive for the departments to use up their provisions as the year-end approaches without getting value for money. Departments have the flexibility, inside overall limits, to reprioritise expenditure to meet their objectives most efficiently. Expenditure which cannot be subject to firm, multi-year limits, is known as Annually Managed Expenditure (this includes social security benefits, payments under the Common Agriculture Policy, debt payments etc). Thus more volatile expenditure is controlled outside three-year totals and helps long-term planning.

In order to realise the value-for-money, India needs to have a medium-term expenditure framework. Budgets should be approved for a three-year cycle with an annual review. All unspent money should be allowed to be carried forward to the next year within the three-year budgetary cycle, and the rule of lapse should be discarded. For capital projects, budgeting should be done for full life-cycle of the project, integrated in a three-year budgetary envelope and funds saved at the end of the financial year should be allowed to be carried forward from year to year till completion of the project.

Another major problem with expenditure optimisation is lack of delegation to administrative Ministries and departments. At present the functioning of the Finance Ministry is highly centralised. It tightly controls spending of money through line-item budgeting, which implies that expenditure limits for every item is fixed, giving no flexibility to a particular department or field outfit to spend money as per their priority. Administrative Ministries have very limited powers to re-appropriate funds from one head to another. The Eswaran Committee of the Ministry of Finance and the Fifth Pay Commission had both recommended that once the budgetary ceilings are determined, the administrative Ministry should be given full freedom to operate within the approved ceilings in respect of each scheme. Administrative Ministries and depart-mental heads should be given full control, authority and flexibility over the money allocated to them in the Budget.

The UK, New Zealand, Australia and many other countries have developed a new philosophy known as the New Public Management to improve public services. The NPM shifts the existing practice of “input orientation” when funds are sanctioned and correlates it to “output” and “results”. The UK has introduced a system of Public Service Agreements which are quasi-contracts between the Treasury and each department about what they would deliver in return for Budget-funding. With the introduction of the PSAs the debate has shifted from outlay, to how effectively resources are being used and whether services are delivering the outcomes that will really make a difference to people’s lives. The PSAs increase local autonomy and they do not prescribe the means or process of delivery and give frontline managers freedom to innovate and take decisions about the most effective and efficient means of delivery.

In India, from fiscal year 2005-06, the govern-ment has come out with a scheme of Outcome Budget and from 2007-08, every Ministry is required to present an Outcome Budget. However, for want of genuine commitment on the part of public officials, to implement the new scheme and increase efficiency and productivity of public expenditure, the scheme has remained on paper only. It is high time we embrace the philosophy of ‘output orientation’ and ‘result achievement’ in budgetary allocation and push down the line the responsibility for resources to the Budget-holders, who are to be given sufficient flexibility and incentive to produce value for money. The spending departments and Budget-holders should be made fully accountable for achieving targets set for them and producing results.

Restoring Fiscal Balance

LARGE fiscal deficits have a variety of adverse consequences for the economy: they reduce economic growth, lower real incomes, and increase the risk of financial and economic crisis. Budget deficits can also lead to higher inflation. The Indian economy is currently facing huge inflation and prices of even essential commodities have risen substantially, causing great suffering to common-folk. Distinguished economist Milton Friedman defined inflation as a ‘monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output’. Is huge public spending mainly responsible for inflation in the economy? To control inflation the RBI has substantially raised the interest rates. This has a huge spin-off effect. It discourages industrial investment as it is very difficult to make an industry viable when interest rates are as high as 15 per cent or more.
Several Western countries, such as Greece, Italy, Ireland, Spain, Portugal, are facing severe crisis due to the burden of high public debt. The most indebted of these countries, Greece, is being bailed out by the European Union on condition of severe austerity, causing huge public resentment and even riots. European countries have now learnt to their dismay that a policy of high public spending through budgetary deficit is counterproductive and will not help revive the economy. This has led to complete reversal of the earlier policy and most countries are going for severe austerity measures by cutting public expenditure. To reduce the heavy burden of over $ 10 trillion debt, the USA is slashing expenditure and President Obama has promised to raise taxes on the rich, despite stiff opposition from the Republicans. Great Britain and Germany are pushing for government austerity, slashing spending and raising taxes despite widespread voter discontent. Germany has passed a constitutional amendment—called Schuldenbremse, or debt break—that outlaws deficit in the national Budget beginning 2016.

India should not lull itself into belief that as a sovereign state it can keep on accumulating excessive debt with impunity. In a globalised world, a state can lose the confidence of the market, which may result in financial cut-off and derail the entire economy. It is time the country wakes up to this reality. The government must take drastic action to cut wasteful expenditure, mercilessly prune schemes which have no utility and impose severe austerity measures on public services. Simultaneously it should take tough and coercive action to impose and collect more taxes and generate revenue surplus. Its foremost agenda should be freedom from crippling debt and restoring fiscal balance. That is the only way we can build a strong and robust economy which will give India a dignified place in the international comity of nations.

Dr B.P. Mathur is a former Deputy Comptroller and Auditor General and author of the book Government Accountability and Public Audit.

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