Home > Archives (2006 on) > 2015 > India’s Fiscal Crisis — Reform Budgetary System to Prevent Insolvency

Mainstream, VOL LIII No 25 New Delhi June 13, 2015

India’s Fiscal Crisis — Reform Budgetary System to Prevent Insolvency

Saturday 13 June 2015, by B P Mathur

Kautilya, the 4th century BC philosopher- statesman, in his magnum opus Arthashastra, had observed that ‘A King with depleted Treasury eats into the very vitality of the citizens and the country’. The UPA Government, by the time it was thrown out of power, left an empty treasury due to its reckless financial policies, with the economy in shambles. Is the new government, which came to power in May 2014, following a policy of fiscal rectitude, containing unbridled public expenditure and mountains of debt? The first full Budget (2015-16) presented by Finance Minister Arun Jaitley does not show that the fiscal policies of this government are substan-tially different from those of the previous government, as it has not shown courage to raise resources through the unpopular route of additional taxation and has continued the soft option of incurring massive debt to finance its burgeoning expenditure.

In the wake of the global economic meltdown of 2008, the USA and West European countries incurred huge public expenditure, financed mainly by debt, but they continue to be afflicted with the problems of slow growth and unemployment. European countries have now learnt, to their dismay, that a policy of high public spending through budgetary deficit is counter-productive and will not help revive the economy. This has led to complete reversal of the earlier policy and these countries are going for severe austerity measures by cutting public expenditure. Greece, Italy, Spain and Portugal, reeling under the burden of heavy debt, have slashed public expenditure, but their economies continue to stagnate with massive unemploy-ment and loss of jobs threatening their economic as well as political stability. A perceptive commentator observed in Newsweek (special issue 2011), ‘never outside periods of total war, has the debt of the world’s most powerful states grown so immense. Never has it so heavily threatened their political systems and standards of living. Public debt cannot keep growing without unleashing terrible catastrophe.’

While India is facing huge problem of debt explosion, threatening the stability of the economy, our policy-makers refuse to recognise the gravity of the problem and remain in denial mood. If we don’t recognise the problem, how are we going to find a solution?

The UPA Government, just before the election of May 2009, went on a spending spree, throwing fiscal rectitude to the wind. Upto 2007-08, the government was following prudent norms and borrowing constituted only 18 per cent of the total expenditure, with over 90 per cent of it being spent on capital expenditure. However, keeping an eye on the elections of mid-2009, the UPA I Government jacked up steeply the expenditure by over 20 per cent in the Revised Estimates (RE) of 2008-09, all of which was met out of borrowing, that jumped two-and-a-half times. Thus 38 per cent of the overall expenditure was financed by borrowing, of which only 27 per cent was spent on capital works. During the five-year tenure of the UPA Government the same trend continued and on an average 35 per cent of public expenditure was met out of borrowed funds. Out of every rupee the government spends 35 paisa was financed by loan. Further, out of the money borrowed, only 33 per cent—one-third—was spent on capital expenditure; the rest was used for current consumption. It is the first principle of public finance, that borrowed funds should be used for capital expenditure, so that income-generating assets are created which can stimulate the economy.

Due to lack of fiscal rectitude, a huge debt repayment liability was created with serious adverse consequences for the economy. Former Finance Minster P Chidambaram admitted belatedly (March 2015) that the stimulus package given in 2008-09 was responsible for the loss of election by his government. (The Times of India, March 8, 2015) Table I gives details from 2007-08 onwards.

Source: Government of India Budget various years.

Is the new NDA Government pursing a policy of fiscal prudence? The Budget of 2015-16 does not show any indication. Thirtyone per cent of government expenditure is met from borrowings—though there is a marginal increase in the capital expenditure to 42 per cent of borrowed funds (one has, however, to wait and see how much productive investment takes place).

Interest payments consume more than one-third revenue earned by the government. This drastically limits the money available for meeting current expenditure, and forces the government to resort to more and more borrowing, landing itself in a perpetual cycle of debt and falling into a debt trap. This is illustrated by Table II.

The problem of budgetary deficit has been a cause of concern for more than two decades. In order to rein in the deficit, a Fiscal Responsibility and Budget Management Act was passed in 2003, effective from 2004. The Act had mandated that revenue deficit may be eliminated and fiscal deficit be no more than three per cent of the GDP by March 2009 (Fiscal Deficit is Total Expenditure less Total Revenue, other than borrowing; while Revenue Deficit is Revenue Expenditure less Revenue Receipts). While for the first few years of the FRBM enactment, the government managed its finances prudently, from 2008-09 fiscal caution has been thrown to the winds and huge deficits are being incurred. Fiscal deficit was hovering around five to six per cent of the GDP between 2008-09 to 2012-13, and declined to around four per cent currently (2014-15), while Revenue Deficit was running between three to five per cent and has currently come down marginally to three per cent of the GDP. Besides the Central Government, States are also running deficit budgets. The fiscal deficit of State to State GDP has been running between two to 2.5 per cent during the last five years. Thus the combined fiscal deficit of the Centre and States has been close to eight per cent of the GDP for the last several years, which has marginally come down to seven per cent currently. Such huge deficits are totally unsustainable.

Budget Deficit and Economists 

Budget deficits get the support of economists following the Keynesian prescription to deal with an economy facing recession. Later econo-mists of all hues used it as a tool of supporting large public spending, particularly in developing countries which are perpetually short of resources. Economist Martin Feldstein1 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.” Feldstein argues that there are severe adverse effects of Budget deficits on capital accumulation, economic growth, future tax rates, and inflation which may lead to financial crises.

I have worked in the Finance Division of several Ministries of the Government of India, besides handling financial management of many large PSUs and was actively associated with the government’s budgeting exercise—its preparation, approval, monitoring and implementation. A correlation between income and expenditure is key to sound Budget-making. In personal finance or corporate finance you invariably correlate expenditure with income while doing budgeting. Why not apply the same principle to the government’s Budget? It is therefore surprising that in all discussions relating to deficit in the government Budget, it is linked to the GDP and not the capacity or effort to raise revenue to meet the expenditure. The GDP is simply a broad estimate of value of a country’s goods and services which have been monetised and its numbers are vague and based on guesstimates of a country’s real income and wealth (particularly in India with weak and unreliable statistical data). Linking deficit with the GDP camouflages the real issue. 

Modern-day economists are prone to build theoretical models in laboratory conditions which have no relation to reality. Thus they play into the hands of ‘smart politicians’, who seize such ‘intellectual support’ to advance their political agenda, and go on merrily on expendi-ture spree, without resorting to the unpopular route of raising resources through taxation. While the Keynesian model of deficit in government Budget to stimulate the economy may be theoretically sound, a more rational course is to prescribe a limit related to the government revenue, beyond which expenditure cannot be incurred—thus, say, in a particular year the expenditure cannot be more than 10 per cent of what is raised by way of revenue. Such an approach would keep a check on politicians who distribute freebies as political gimmickry without bothering for their budgetary implications.

Many economists themselves are aware of the limitation of their profession to prescribe public policy. Paul Krugman, an Economics Nobel Prize winner, castigated the profession of economists for constructing mathematical models which have no relation to reality and their culpability in creating a situation which resulted in the economic crisis of 2008. Robert Coase, another Nobel Laureate in Economics, has faulted economists for their theoretical approach of economisation and isolating themselves from the ordinary business of life.

 Porous Tax Regime 

It is through taxes, both direct and indirect, that public expenditure is financed. While expendi-ture is increasing every year, there has not been commensurate growth of tax revenue. Desperate for revenue, the governments—both UPA and NDA—have been selling shares of profitable PSUs, without any economic justification. These sales fetched Rs 18,253 crores in 2013-14 and Rs 26,353 crores in 2014-15 and have been budgeted at Rs 69,500 crores for 2015-16. It is pointless to sell shares of companies such as NTPC, BHEL, SAIL, RINL, NALCO etc. which are national jewels. All these years PSUs are bringing substantial dividends to the government’s coffer—Rs 25,921 crores in 2013-24 and Rs 28,243 crores in 2014-15. Selling shares of profitable PSUs tantamounts to selling the family silver to pay for the grocer’s bill and killing the bird which lays the golden egg. 

Tax revenue is financing only around 50 per cent of the expenditure, as it has not kept pace with burgeoning expenditure as is evident from Table III below.

The main reason for the lack of buoyancy in taxes is the government’s lack of ‘will’ to raise taxes by taking hard and unpopular decisions. Tax revenue as percentage of the GDP (Central Government) is around 10, as compared to the Tax-GDP ratio of more than 20 per cent in Australia, France, Belgium, Italy, the Netherlands and the UK and close to 30 per cent in the Scandinavian countries such as Norway and Denmark. If we take the overall tax revenue of the government (which includes the States), the Tax-GDP ratio in India is 18 per cent compared to over 25 per cent in Australia, Japan and the USA, 40 per cent and more in Germany and the UK, and upwards of 45 per cent in Belgium, France, and the Scandinavian countries such as Norway, Sweden and Denmark. The average tax-GDP ratio in the OECD countries is 34 per cent (2013), with Denmark recording the highest collection at 48 per cent. In India with such low tax recovery, it is wishful thinking that she can provide food and employment security to her citizens.

There are several reasons for the low tax collection. There is a huge problem of black money, estimated to be 50 per cent of the economy, and large scale tax evasion due to corruption and a weak enforcement machinery. The government’s taxation policy is perverse. A large number of tax—preferences have been given by way of special tax rates, exemptions, deductions, rebates, deferral and credits; as a result a huge revenue is foregone. Every year the Revenue Budget document gives information about the revenue foregone. In 2011-12, Rs 5,33,500 crores (direct and indirect tax) was foregone, which was around 60 per cent of the estimated gross tax collection of Rs 8,89,000 crores, and in 2012-13, Rs 5,74,000 crores was estimated to have been foregone which is 55 per cent of the gross collection of Rs 10,38,000 crores. During 2013-14, the revenue foregone was Rs 5,49,984 crores, which is 48 per cent of the gross tax collection of Rs 11,38,734 crores, and estimated at Rs 5,89,285 crores in 2014-15, which is 47 per cent of tax collection of Rs 12,51,391 crores (from the 2015-16 Budget the Finance Ministry is using the word ‘Revenue Impact of Tax Incentive’ to camouflage its soft tax policy). Table IV (next page) gives the estimated tax revenue forgone, which is close to 50 per cent of the gross tax collection of the Central Government.

India has a very soft tax regime for personal income tax. According to Forbes, the country has 69 dollar billionaires whose combined wealth is $ 300 billion, equivalent to one-fourth of the country’s GDP. These super-rich are taxed at the same rate as an average citizen as the highest tax rate is only 30 per cent (with three per cent educational surcharge). Even liberal economies of Europe and the OECD, known for low taxation structures, have high tax rates for the rich. The highest marginal income-tax rate is 45 per cent in France, Germany and Australia, 48 per cent in Canada and Norway, 50 per cent in Belgium, Japan and the UK, 52 per cent in the Netherlands, 55 per cent in Denmark; and 57 per cent in Sweden (2012). It may be mentioned that before 1980—the era of neo-liberal model of economic development—the top marginal rate in the OECD, the rich countries club, ranged between 60 to 80 per cent with Sweden touching a peak rate of 87 per cent (1975). In OECD countries taxes on income alone account for 11 per cent of the GDP (2013).

Corporates in India are also taxed low. The tax rate on companies is 30 per cent and with surcharge it comes to 32.5 per cent. However, due to various concessions, exemptions etc., the effective rate comes to only 23.22 per cent (2012-13) on those companies which report profit (only 55 per cent companies reported profit). A large number of companies ‘avoid tax’ due to creative accounting practices. The owners and top management of these companies siphon off huge amounts of salary, allowances, bonus and numerous other techniques, rather than ploughing back the profits into the company for productive investment. One fails to see the logic of the Finance Minister in his Budget speech of February 2015, proposing reduction of the corporate tax to 25 per cent in the next four years.

Due to the policy of liberalisation, customs duty rates have been reduced on a large number of items which, if not imaginatively done, not only reduces the revenue collection but has serious adverse effects on the economy, both in the agriculture and industrial sectors. The flood of Chinese imports are playing havoc with India’s manufacturing sector. India imports 60 per cent of edible oil requirement of 18-19 million tonnes annually. It imported 10.1 mt valued at Rs 56,000 crores in 2012-13 and 9.1 mt valued at Rs 51,700 crores in 2013-14 (March—February). There has been a very low duty regime (for a long time duty on crude oil was nil and refined oil 7.5 per cent; it was raised to 2.5 per cent on crude oil and 10 per cent on refined oil in 2013 and further raised to 7.5 per cent on crude and 15 per cent on refined oil in December 2014). Such low duty results not only in huge revenue loss, but has the long-term effect of destroying the economics of the domestic oil-seed industry and farmers losing interest in its production as they get priced out. The most glaring case is of gold, which due to the liberal import regime is a significant contributor to the country’s unsustainable current account deficit. During 2011-12 and 2012-13 gold imports were of the order of $ 62 billion and $ 56 billion, accounting for 12 and 11 per cent of the country’s import. Due to social factors, India has a huge appetite for gold consumption; this coupled with low import duty and liberal loans given by banks and the NBFC, there was an import surge. The government took several measures to curb imports, including duty hike, and the import declined by 40 per cent to $ 33.5 billion in 2013-14. However, in 2014 the government has again relaxed its policy and huge imports are taking place putting severe pressure on the current account deficit. The government can mop up huge revenue by raising duty and take other preventive measures to restrict the flow of gold in the country. The argument that high customs duty will encourage gold smuggling is specious—an effective enforcement machinery should be put in place

Corruption is the most important reason for low tax collection in India. Raising revenue by better tax-compliance, rationalising the taxation structure and curbing the menace of black money generated in the domestic economy is not an item on the government’s priority agenda. The public and press also do not understand the gravity of the issue and hence it is not discussed in the public space.

Burgeoning Public Expenditure 

The Wage Burden of Public Employees

The government’s expenditure on salary and allowances of its employees has steeply increased due to the Sixth Pay Commission’s award. In 2007-08, the salary and pension bill of the employees (including the defence forces) was a little over 16 per cent of the Central Govern-ment’s revenue but after the Pay Commission’s award it has jumped to more than 25 per cent of the revenue. Table V illustrates this.

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 107 per cent (December 2014) of his basic salary. Huge benefits—such as, heavy house-rent allowance, 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 the 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 wage bill, as it does not include the cost of the employees of autonomous institutions who are controlled/funded by the government and enjoy the same terms and conditions of service as Central Government employees and are fully or partially funded by the government. Teachers and staff working in colleges and universities 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 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 the Central pay-scales, irrespective of the availability of resources. According to data available in the 13th Finance Commission report (2009-10), the percentage of expenditure on the salary of employees plus pension to the State’s own revenue (tax and non-tax) runs to between 50 to 60 per cent in West Bengal, UP and Punjab, 70 per cent for Orissa and around 130 per cent in Assam and Bihar. The 14th Finance Commission (December 2014), which has given another huge bounty to the States, has not even looked into the numbers of State Government employees and their cost to the exchequer and simply skirted the issue.

In addition to the wage bill, there is a huge committed liability of interest charges on debt incurred both by the Central and State govern-ments, as mentioned earlier. After meeting these liabilities (which may run upto 75 per cent of the revenue earning), very little money is left for the government’s multifarious activities. Can the government afford such largesse as wages for public employees? The productivity of the government employees is abysmally low in India. Several high powered Commissions—such as the Fifth Pay Commission (1997), Expenditure Reforms Commission (2000-01), Second Administrative Reforms Commission (2008)—have come out with laudable suggestions to reform the public administration, but they remain unimplemented. 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. On top of it, the UPA Government had appointed another Pay Commission, which is currently busy finalising its report (March 2015), to grant further largesse to public servants. It is apparent, the government has no interest in economising expenditure. No wonder, the people say that the government exists for the benefit of the government servants alone! 

Plan Schemes 

A large chunk of public funds is not optimally used and this is the main reason for the dismal performance of the economy. From the beginning of the 11th Plan (2007-08), the government had greatly enhanced the expenditure on Plan schemes, 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 expenditure was doubled to Rs 4,12,400 crores, with only a small share being spent on capital expenditure. The same trend was followed in the 12th Plan. In 2012-13, the Plan expenditure has been Rs 4,13,600 crores, with only Rs 84,400 crores spent on capital expenditure (20 per cent), while in 2013-14, the expenditure was Rs 4,53,327 crores with capital expenditure of Rs 1,00,595 crores (22 per cent). In 2014-15 (RE), the Plan expenditure was Rs 4,67,934 crores with capital expenditure of Rs 1,01,051 crores (22 per cent). On an average only about 20 per cent of the Plan funds are being used for capital outlay and the bulk of the money is used for revenue expenditure, which does not create long-term income generating assets. A large chunk of this money is spent on social sector programmes in the area of poverty alleviation, health and primary education and operated as Centrally Sponsored Schemes (CSS). Some of the major schemes are the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS); Sarva Shiksha Abhiyan (SSA); National Rural Health Mission (including Urban Mission), Pradhan Mantri Grameen Sarak Yojna (PMGSY); Indira Ayas Yojna (IAY), National Rural Drinking Water Programme (NRDWP).

The NDA Government has brought major changes in development planning by abolishing the Planning Commission. Nevertheless, most of the schemes of the UPA Government are continuing. However, there is a major change in the funding pattern. The 14th Finance Commission has increased the States’ share of taxes to 42 per cent from the existing 32 per cent, giving more resources to the States. This has necessitated change in Central Assistance to the State Plans, which are now classified in three categories: schemes fully supported by the Union Government; schemes to be run with changing sharing pattern; and schemes for which no assistance will be given. The allocation for some key schemes for 2015-16, which are fully supported by the Centre, as per the earlier pattern, are as follows: MGNREGS—Rs 33,700 crores (Rs 32,456 crores in 2014-15); Prarambhik Shiksha Kosh (PSK)—Rs 27,575 crores (Rs 22,250 crores in 2014-15); PMGSY—Rs 10,100 crores (Rs 9960 crores in 2014-15). For schemes like the National Health Mission, where the funding pattern has changed, an allocation of Rs 18,000 crores has been made for 2015-16, as compared to an outlay of Rs 17,434 crores in the previous year 2014-15.

Hitherto, the practical working of Centrally Sponsored Schemes (CSS) was extremely complicated and defied logic. There were 137 CSS (reduced technically to 66 sometimes back) with varying sizes, objectives 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 biggest problem with these schemes was the one-size-fits-all approach which the States resented, as they tied their hands and gave them little operational manoeuvrability.

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 is being spent annually, and the benefit of the programme is not reaching the beneficiaries. The objective of the MGNREGS is to enhance the livelihood security of people in the rural areas by guaranteeing 100 days of wage employment in a financial year to a rural household whose members volunteer to do unskilled work. While the MGNERGS has been able to reduce distress migration to some extent and helped improvement in the bargaining power of the agriculture labour, it has huge spin-off effects. The MGNREGS is simply a dole given to rural labour—it has created a huge shortage of labour for agriculture farming during the sowing and harvesting seasons, 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. Many experts feel that instead of doling out huge money, investment should have been made in increasing rural productivity by investing in durable assets such as irrigation canals, warehouses, scientific research to enhance productivity etc., which would have created prosperity and employment opportunity in the future. It is the same story with the rural health programme. 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 have been referred for CBI probe. The schemes of primary education and universal literacy have gaping holes and focus only on numbers. The NGO, Pratham, brings out an alarming picture—after several years of schooling, children cannot do simple reading, writing and most elementary arithmetical sums.

One need not, therefore, feel sorry that the Planning Commission has been abolished. Having said this, there is definite need for some high level national think-tank to do policy planning in areas such as energy, transport, industry, health and education etc., vital for national development and chartering the future course of action. The government has constituted a Niti Ayog, but one has to wait and watch its functioning, before one can say whether it fulfils the role of strategic planning.

The devolution of more resources to the States, as recommended by the Finance Commission is a welcome step. However, the more fiscal space given to States will yield results only when they show greater fiscal responsibility and improve their financial administration.

Wasteful Expenditure: MPLADS

Our elected representatives do not feel that they should set an example of austerity. 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’s Local Area Development Scheme (MPLADS), introduced by the Narasimha Rao Government in December 1993. Under the scheme each MP was allocated Rs 2 crores per year, which has been raised to Rs 5 crores from 2012-13, and he/she can select works to be implemented in his/her constituency (in case of Rajya Sabha members, anywhere in the State). Between 1993 and 2011-12, a sum of over Rs 26,000 crores was spent on the scheme. From 2012-13, when the allowance has been raised, the annual liability has increased to Rs 3950 crores and upto March 2015, Rs 34,850 crores has been spent.

Experts have severely 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 discontinuance. 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 legis-lators, 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 fund. Taking a cue from the Centre, almost every State has established an MLA’s fund, with a huge outgo from the government coffers. The new NDA Government has also taken a soft approach and allowed the scheme to continue. The scheme is ab-initio unsound and unworkable and should be abolished. 

 Part II Poor Outcome of Public Expenditure

One of the main reasons for the poor outcome in terms of delivery of public services is the out-dated budgetary practices followed by the Finance Ministry; as a result optimum use of public money cannot be made by the spending departments. The administrative Ministries, departmental heads and field outfits face two major problems on 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, the huge amount of money allocated in the Budget gets surrendered every year as it cannot be utilised. The audit report of the CAG on the Union Government Accounts every year point to the huge surrender of money by various Ministries, which calls for total overhaul of the existing budgetary system. 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 in 2008-09 (five per cent of the Budget) and Rs 40,600 crores in 2007-08 (six per cent of the Budget). The money surrendered related to critical public services such as School Education and Literacy, Higher Education, Health and Family Welfare, Road Transport and Highways and Power.

The most alarming position was that of the Ministry of Defence, which could not use the Capital Outlay of Rs 15,300 crores meant for the modernisation of the armed forces. The same trend has been continuing in subsequent years. During 2011-12, Civil Ministries surrendered a sum of Rs 1,28,000 crores, 9.5 per cent of the allocated Budget (other than Railways, Posts and Defence). This included Rs 42,368 crores (28 per cent of the Budget) for Rural Development, Rs 7280 crores for Power Generation, Rs 2335 crores for Higher Education, Rs 1010 crores for School Education and Literacy and Rs 2130 crores for Health and Family Welfare. The Defence Ministry surrendered Rs 3000 crores allotted for the armed forces modernisation. In 2012-13, Civil Ministries surrendered a sum of Rs 1,20,600 crores (8.70 per cent of the allotted Budget). This included Rs 4690 crores (seven per cent of the budgetary allocation) for School Education, Rs 4870 crores (19 per cent) for Higher Education, Rs 5110 crores (17 per cent) for Health, Rs 9200 crores for Power (84 per cent) and Rs 26,270 crores (20 per cent of the Budget) for Rural Development. For Defence capital purchases a sum of Rs 9044 crores (11 per cent of the allocation) was surrendered, as it could not be spent.

There are some fundamental reasons why Ministries and departments are unable to use the allocated 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.

Reforming Budgetary Systems

Most developed countries have resolved the problem of efficient utilisation of budgetary allocation by modernising expenditure manage-ment systems and shifted to the medium-term expenditure framework.2 The UK, Australia, New Zealand and the Scandinavian countries have moved to multi-year Budget, with a proper linkage with annual Budgets. End-year flexibility removes the perverse incentive for the departments to use up their provisions as the year-end appro-aches without getting value for money. Depart-ments have the flexibility, inside overall limits, to reprioritise expenditure to meet their objectives most efficiently. In order to realise value-for-money, we need 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.

The second major problem with expenditure optimisation is lack of delegation to the 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 (1996) and the Fifth Pay Commission (1997) had both recommended that once the budgetary ceilings are determined, the administrative Ministries and departmental heads should be given full control, authority and flexibility over the money allocated to them in respect of each scheme approved in the Budget.

The UK, New Zealand, Australia and many other countries have developed a new philo-sophy of expenditure management which shifts the existing practice of ‘input orientation’ when funds are sanctioned and correlates it to ‘output’ and ‘results’. In a half-hearted approach, the Ministry of Finance has prescribed presentation of Outcome Budgets and from 2007-08, every Ministry is required to present an Outcome Budget to Parliament. However, due to poor designing and want of genuine commitment on the part of public servants to increase efficiency and productivity of public expenditure, the scheme has remained on paper only and is meeting the same fate as ZBB (Zero-based-Budgeting) introduced with much fanfare in 1987-88.

Performance-based Organisations

During the last three decades several developed countries, which have faced the problem of inept bureaucracies and fiscal profligacy, have met the challenge by taking some bold reform measures, in what has come to be known as the philosophy of the New Public Management (NPM). The NPM emphasises deregulating internal management of public bureaucracies and decen-tralising and streamlining various management processes such as budgeting, personnel, and procurement. As part of budgetary reform, the NPM envisages change in the existing budgetary practice of ‘input’ orientation where funds are sanctioned without corelating it to the ‘output’, and shifts emphasis on what ‘results’ are delivered when funds are parcelled out. The USA has enacted a Government Performance and Rsults Act 1993, with a view to improve efficiency and effectiveness of the government operations and to focus on results, service quality and public satisfaction. New Zealand has put in place a highly efficient public management system which is governed by three key legis-lations—State Sector Act 1988, Public Finance Act 1989 and the Fiscal Responsi-bility Act 1994. The objective is to improve productivity of public managers, give them greater flexibility, focus on what they produce and to promote consistent good quality fiscal management.

The most fundamental changes have been introduced by the UK. The first Initiative in this regard was taken by Margaret Thatcher who introduced the Finanical Management Initiative (1982) whose emphasis was on budgeting for results and providing value for money. This was followed by the Next Step Initiative (1988) under which most departments concerned with delivery of public services were converted into Autonomous Agencies, with wide powers in personnel, financial and operational matters. These reforms were continued by the govern-ments of John Major and Tony Blair who launched a Citizen’s Charter (1991) and intro-duced Public Service Agreements (1998). With the introduction of PSAs, the debate has shifted from outlays to how effectively resources are being used and whether the services are delivering the outcomes. PSAs increase local autonomy and are focussed on results, not prescribing the means or process of delivery and give front managers freedom to innovate and take decisions about the most effective and efficient means of delivery.

As part of the NPM, Britain, New Zealand, Australia, Canada, Singapore, Japan, the USA and many other countries have revamped their bureaucratic systems and shifted to professional magement of the bulk of government activity through creation of ‘Agency’ or ‘Performance-based Organisation’. In Britain the Chief Executives of the Agency are selected by the Public Service Commission, through competition open to public and private sector candidates and hired on the basis of a contract. The Chief Executive reports directly to the Minister and is personally accountable for service delivery within the Budget. They enjoy full freedom to manage operations within their framework document and annual agreements. Each agency negotiates an annual performance agreement with its parent depart-ment that includes measurable targets for financial performance, efficiency and service quality. The creation of Executive Agencies has resulted in substantial gains in efficiency in the British public services. A Treasury and Civil Service Committee of the House of Commons observed that Executive Agencies have brought about ‘overall transfor-mation in government’ and termed it as ‘the single most successful reform programme in recent decades’.

There is need for embracing the philosophy of the New Public Management and Agencification model for revamping governance in India as it makes the government servant accountable for delivering results. This author has also advocated this model in his books, Governance Reform in India (2005) and Ethics in Governance ((2014).3 Many scholars in India, such as former IIM Director Pradip N. Khandwalla, have supported the Agencification model.4 Khandwalla has developed detailed matrix for introducing the Agencifi-cation model and identified the organisations most suitable to be converted into Agencies. He says: ‘Agencification seems to represent the best hope of making the machinery of governments in India efficient, economical, sensitive to the citizens’ needs and staff needs, clean, objective and agile. This it promises to do basically by transforming the bureaucratic management into professional, stakeholders-sensitive, performance oriented management.’

Part III

Budgetary Deficit and Inflation

One of the biggest problems that the common man faces in the country is high inflation in the economy, which erodes his real income. Nobel Prize-winning economist Milton Friedman had said: ‘Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.’ Are the huge public spending and deficits in government Budget responsible for high inflation in the Indian economy?

According to the historical data of the Consumer Price Index (CPI) brought out by the European Union, India has one of the highest inflation rates in the world. The CPI is a measure of the average price which the consumers spend on a market-based ‘basket’ of goods and services. The average inflation in India in 2013 was 10.92 per cent and 6.37 per cent in 2014 (a year’s average inflation rate is the average of the monthly inflation rates in the calendar year). Compare this with the average inflation rate in 2013 of some leading economies: China 2.57; Denmark 0.78; France 0.86; Germany 1.51; Great Britain 2.56; Japan 0.36; Sweden -0.04; the USA 1.47 per cent. The average inflation rate in 2014 was as follows: China 2.06, Denmark 0.57, France 0.51 per cent, Germany 0.91, Great Britain 1.46, Japan 2.74, Sweden -0.18, the USA 1.62 per cent. In developed countries, the average annual inflation rate over a long period of time has remained within the range of one to two per cent. In the Euro-area inflation averaged around two per cent in 20 years upto 2013. On the other hand, in India the average inflation during the last span of 20 years has been around seven to eight per cent annually. The average of the CPI rates during the last five years has been 9.5 per cent (2014—6.37 per cent, 2013—10.92, 2012—9.30, 2011—8.87, 2010—12.11 per cent). Thus in five years time the value of the rupee has come down to around 65 paisa. According to the formula adopted by the Income Tax Department for levy of Capital Gains Tax, the cost index for 2013-14 is taken as 939, with 1981-82 as the base year for which it is 100. Thus in a 32-year period the real value of the rupee has come down to 11 paisa.

High inflation can cause havoc in an economy. Germany learnt a bitter lesson after the First World War, when currency notes were stuffed in a bag to buy a loaf of bread, and public anger against unfair peace treaty terms became a contributory factor in Germany’s rearmament and triggering of the Second World War. Lenin had observed: ‘There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.’ Endorsing Lenin, celebrated economist J.M. Keynes, in his book Economic Consequences of Peace, expressed serious adverse consequences about inflation: ‘By continuing the process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of its citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some.’

The high inflation that we are having in India has a disastrous effect on the poor and fixed income groups. While the real income of the poor goes on decreasing, the rich and powerful, who are holders of physical assets and major borrowers of money from banks, their assets go on increasing, while the borrowing cost keeps on decreasing.

It needs to be seriously debated whether, the govern-ment’s huge spending through borrowed funds is a principal factor behind the country’s high rate of inflation. 

The Way Forward

In order to improve the finances of the country we have to take bold action both on the fiscal policy and its implementation. It is only through improved governance and curbing corruption that we can prevent large scale evasion of tax and curb generation of the black economy. For reduction of large deficits in the Budget and heavy public debt burden, the following measures are suggested:

1. A legislation should be passed by Parliament placing a ceiling on government borrowing. Article 292 of the Constitution has a provision to that effect.

2. The provision of the FRBM Act should be strictly enforced. There should be no revenue deficit and fiscal deficit should be no more than three per cent of the GDP. A long-term objective should be zero deficit in the Budget. A still more effective course is to mandate that in a year, governments both at the Centre and States cannot incur expenditure above a certain percentage of revenue it collects (say, 10 per cent), and over a long term the Budget should be balanced. 

3. There should be a law that the government cannot borrow for current consumption, and all borrowings be only for capital works and projects. As a general rule, the government should incur expenditure on any new schemes and activity above a certain level (say, Rs 1000 crores) only when it shows how additional money will be raised to finance it through fresh taxation or other revenue-generating measures. 

New Zealand’s FRMB Act states: ‘Once prudent level of total Crown debt has been achieved, maintain this level by ensuring that, on an average, over a reasonable period of time, the total operating expenses of the Crown do not exceed its total operating revenues’ (prudent debt level is interpreted to mean net public debt in the region of 20 to 30 per cent of the GDP)’. Germany has passed a constitutional amendment called Schuldenbremse, or debt-break, that outlaws deficit in national Budget beginning 2016.

4. Additional resources should be raised by plugging the loopholes in taxation law and withdrawing unjustified exemptions and concessions. Income-tax rates should be hiked for the super-rich and those earning high income without ‘sweat of their labour’. Customs and excise tariff should be rationalised to give incentive for domestic production and national self-sufficiency and prevent unnecessary imports. 

Tax policy should aim at the Central Government’s tax-revenue realisation of 15 per cent of the GDP, with the long-term objective of achieving a target of 20 per cent. The overall tax-revenue of the government (Centre and State) should target at 25 per cent of the GDP, with the longer term objective of 30 per cent.

5. Serious attempts should be made to curb the menace of Black Money which is estimated to be 50 per cent of the economy and escapes tax-payment. 

6. There is a need 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 rolled over to the next year. For Capital Projects, funds should be provided for full life-cycle of the project.

7. There should be budgeting for results—Mission-driven budgets or Outcome Budgets. Budgets should become contract for performance. In exchange for agreed resources, Ministries/departments should produce specified targets set for them. This is possible when the institu-tional framework of autonomous Performance-based Organisations, with full operational autonomy, are created. This would simultaneously ensure accoun-tability of public officials to deliver results.

Restoring Fiscal Balance

Gunnar Myrdal, the Nobel Prize-winning social scientist, had warned that India is a ‘soft state’ and its rulers are unwilling to impose obligation among the governed, and a corresponding unwillingness on their own part to obey rules. It is time our rulers start ‘governing’ the country by taking tough policy measures and tighten fiscal as well as administrative discipline. It should be remembered that 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. 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 and the international community, which may result in financial cut-off and derail the entire economy.

Contemporary historian Niall Ferguson5 argues that in the past civilisations have collapsed due to financial bankruptcy. He cites case of Spain in 16th century, France in 18th century—a major factor contributing to the French Revolution of 1789 and disintegration of the Ottoman Turkish empire in the 19th century. He elaborates that Britain’s declining influence after the Second World War and the USA currently, has been due to their unsustainable debt liability, particularly to foreign creditors. ‘It is important to remember that most cases of civilisational collapse are associated with fiscal crises as well as war. [They] were preceded by sharp imbalances between revenue and expenditures, as well as by difficulties with financing public debt.’

It is time the government wakes up to the reality of fiscal discipline. 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. The government’s foremost agenda should be freedom from crippling debt and restoring the fiscal balance. The country needs to listen to Kautilya’s sagacious advice, ‘All State activities depend first on the Treasury. Therefore the King shall devote his best attention to it.’


1. Martin Feldstein, Budget Deficit and National Debt, RBI: L.K. Jha Memorial lecture, January 13, 2004, available at http://www.rbi.org.in/Scripts/Publications View.aspx? Id=5915

2. For detailed discussion see B.P. Mathur, ‘Productivity of Public Expenditure’, Indian Journal of Public Administration, No 3, July-September 2005; B.P. Mathur, Governance Reform for Vision India—Ch 7, Streamlining Budgetary Systems, New Delhi: Macmillan, 2005; also see A. Premchand, Control of Public Money, New Delhi: Oxford University Press, 2005.

3. B.P. Mathur, Governance Reform for Vision India, New Delhi, Macmillan, 2005 and Ethics in Governance, New Delhi: Routledge, 2014.

4. Pradip N. Khandwalla, Transforming Government through New Public Management, Ahmedabad: Management Association, 2010 ; S.K. Das, Building a World-Class Civil Service, New Delhi: Oxford University Press, 2010; Uma Medury, Public Administration in the Global Era, Hyderabad: Orient Black Swan, 2010.

5. Niall Ferguson, CivilisationThe West and the Rest, London: Allen Lane, 2011, pp. 309-311.

B.P. Mathur has worked in the Finance Division of several Ministries of the Government of India, which included a stint as the Additional Secretary and Financial Adviser, Ministry of Steel and Mines, besides serving as the Deputy Comptroller and Auditor General and Director, National Institute of Financial Management. He holds a doctorate and post-doctorate in Economics from the University of Allahabad and is author of books on economics, finance and governance-related issues. His latest book is Ethics in Governance—Reinventing Public Services (Routledge, 2014). His e-mail is: drbpmathur@gmail.com.