Kelkar rejection underlines
India's fiscal imprudence By Swati Lodh Kundu
That India's
fiscal situation is in a mess is but stating the
obvious. That a profligate government may not want
to walk the talk of fiscal consolidation may be a
little less obvious, given its high decibel intent
of fiscal consolidation.
To begin at the
beginning, the newly appointed Finance Minister P
Chidambaram (who replaced the then finance
minister and current president of India, Pranab
Mukherjee, who with his inane utterings and
actions in his avatar as a finance minister was
leading the economy to a precipice) appointed
Vijay Kelkar (former finance secretary and advisor
to the finance minister) to head a committee to
prepare a report outlining a roadmap for fiscal
consolidation in a medium term framework in
pursuit of the Fiscal
Responsibility and
Budget Management (FRBM) Act and related targets.
The committee was also expected to outline
the necessary steps required for a mid-term fiscal
correction during the fiscal year ending March
2013 (FY13). The caveat was that these corrections
have to be necessarily feasible from a political
economy perspective so as to carry credibility.
The Kelkar report, which was tabled last
Friday, September 28, suggested some drastic
measures in the form of a mid-course correction
given that, in their view, the result of doing
nothing would mean a series of dangerous
ramifications:
The central government fiscal deficit for FY13
would be 6.1% of gross domestic product - or GDP
(as against budgeted target of 5.1% for FY13 and
5.8% of GDP recorded during FY12). This would be
engendered by potential shortfall in gross tax
revenues by around 600 billion rupees (US$11.5
billion) and the budgeted expenditures on
subsidies likely to exceed target by 700 billion
rupees.
The fiscal stress will also manifest itself in
the form of debilitating twin deficit, what with
the current account deficit for FY13 likely to be
about 4.3% of GDP (a tad higher than the 4.2% of
GDP recorded during the previous financial year).
This, according to the report, at a time when the
world market and capitals flows are exceedingly
fragile and where financing of this magnitude is
creating huge risks for macroeconomic and external
stability
The gross borrowing requirement as a result,
already high, is likely to exceed the previous
year's level by a huge margin (likely 5.8% of GDP
in FY13 as against 5.4% of GDP during FY12). Such
a large borrowing requirement would lead to a
crowding-out of private sector financing for
investment.
Given that the fiscal time
bomb is ticking away and credit rating agencies
are on the throes of downgrading India's sovereign
rating, clearly doing nothing is not an enticing
option. As per the Kelkar Committee report, at the
core of his suggested fiscal consolidation
strategy lies a committed effort to undertake "a
frontal attack on inequitable subsidies". The
recommendations with regard to subsidy reduction
are as follows:
Oil
subsidies: The aim would be to eliminate
half of the diesel per unit subsidy during this
year itself by March 31, 2013, and the remaining
half over the next fiscal year. The liquefied
petroleum gas (LPG) subsidy should be eliminated
by FY15 by reducing it by 25% this year, with the
remaining 75% over the next two years. For
kerosene, the objective should be to reduce the
subsidy by one-third by FY15.
To achieve
this, their recommendation is to increase the
price of diesel with immediate effect by 4 rupees
per liter , that of kerosene by 2 rupees per liter
and that of LPG by 50 rupees per cylinder. This
should be followed by smaller and frequent
revisions as necessary to meet the broader
objectives. They believe that such steps would
reduce the projected under recovery by 200 billion
rupees over the next six months.
Fertilizer subsidy: The
immediate focus should be on revision in the price
of urea. This would not only reduce the subsidy
burden but also alter the imbalance created by a
skewed consumption pattern engendered by cheap
availability. They recommended an increase in
price of urea by 10% during the first year and
subsequent increases should be made as per a price
revision mechanism as laid down by the committee.
Food subsidy: The Central
Issue Price (CIP) should be linked to the Minimum
Support Price (MSP). MSP is used as a tool to
incentivize farmers to produce food grains and
help them in a period of crop failures. However,
like all other social sector spending, it has
become a tool to appease the farmers whose vote
counts big during elections. While MSPs are
supposed to be used as a tool to compensate
farmers especially during periods of stress (which
means that during normal periods, MSPs ought to be
lowered), in reality MSPs in India has always
moved in one direction, viz upward. The continuous
upward trend in MSPs, create distortion in the
market.
There has never been even a
single instance when specific hikes in MSP (say
drought relief, or bonus to meet specific
procurement targets) have been withdrawn next
year. Rather these act as a benchmark for prices
in the next year. The period 2007-08 marked a
major year of price distortion (during the rule of
the United Progressive Alliance) when steep
increases in MSPs were announced. Since then, MSPs
have been rising very fast. While, between 1989-90
and 2006-07, the MSPs increased between 2.5% and
6% per annum, it rose between 9% to 19% per annum
between 2006-07 and 2011-12. As MSPs form the
benchmark for market prices, these tend
to remain elevated even if the
demand-supply dynamics require prices to come
down.
Trend in MSPs
(Rupees per quintal) over the years
Source: Directorate
of Economics & Statistics, Dept. of
Agriculture
With a fast rising MSP, the economic cost
of food grains (including procurement, transport
and storage) far outstrips the issue price leading
to burgeoning food subsidy.
Apart from
subsidies, the Kelkar Committee has come up with
many innovative proposals aimed at moving toward
fiscal consolidation. These include a speeding up
disinvestment, revamping tax laws and tax
administration, monetizing vast reserves of land
owned by the government and public sector
agencies, and moving to a system of cash transfers
to ensure better subsidy administration.
However, the government (which was
instrumental in setting up the committee) decided
to reject the findings, mainly on the grounds that
the suggestions with regard to subsidy reduction
went against the grain of political reality. This
is not a surprise given that some important state
level elections are around the corner and the
general assembly election is about a
year-and-a-half away.
By announcing the
formation of the committee, P Chidambaram wanted
to showcase to the world his commitment towards
FRBM. Question is, did he expect a benign report
which would have stated that things were only a
wee bit bad rather than expose the actual extent
of the problem? If he wanted a truthful report,
then why set up the committee now when it is quite
clear that the government is not in a position to
act given the political reality?
While
there's no gainsaying the fact that reduction of
subsidies is of paramount importance, no political
party can afford to take steps as suggested by the
Kelkar Committee, however prudent, as populism
lies at the core of every election manifesto one
comes across.
By rejecting this report,
the government is giving out a clear signal that
some recent positive policy decisions
notwithstanding, populism will stay and the
economy will continue to pay the price for such
lack of prudence. Little do they realize that,
while they try to appear to be "poor friendly", in
the longer run it is the poor who will suffer the
most as economic growth stalls, inflation rises
and, in the none too distant future, even the
resources for such populism will no longer be
forthcoming.
Swati Lodh Kundu is
a New Delhi-based commentator.
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