The 2012 Union Budget moves towards fiscal correction, but does not go far enough. The quality of fiscal consolidation is also in the right direction, but not enough to address the massive public investment deficit. Other constraints holding down growth and holding up inflation are recognised, though not with enough granularity. The Medium-Term Expenditure Framework, prescribed by the 13th Finance Commission and finally promised in the Fiscal Responsibility and Budget Management (FRBM) Amendment, comes one year too late - but better late than never.
Fiscal correction at the Centre is an imperative at a time when inflation still at seven per cent, a depreciating rupee and slowing growth together point clearly to supply-side constraints. Fiscal deficits of states are no longer a worry, because incentives designed by successive Finance Commissions have structured financial rewards into the system for states practising fiscal prudence. West Bengal remains an exception - but, in all fairness, the interest bill it faces today is a legacy from an earlier failure to enact fiscal responsibility legislation in line with other states.
This is not to say that expenditures on social-sector schemes at state level are reaching their targeted beneficiaries. Horror stories abound of state-level hijacking of food meant for the most vulnerable segments of the population. Fiscal discipline should rightly imply both restraint in aggregate expenditure, and well-monitored expenditure. The first is structurally in place at the state level. The second eludes us still.
Back at the Centre, the fiscal consolidation in the Medium-Term Fiscal Plan - after the disastrous loss of control in 2011-12 - is directionally correct, if not ambitious. The slow pace is officially justified on the grounds that the promise of sharper cuts would have lacked credibility. Incidentally, the final GDP numbers for 2011-12 will probably be a bit higher, so the final fiscal deficit percentage for the current year may be a touch lower than the revised estimate.
But accepting the deficit for this year at 5.9 per cent, the headline fiscal correction next year amounts to 0.8 per cent of GDP. One-off revenue receipts from spectrum sales and disinvestment, which are episodic and therefore not a predictable component of the revenue-generation properties of the system, should ideally be removed from this, so as to obtain the structural content of the fiscal correction. The Budget papers do not permit a detailed breakdown of telecom receipts into recurrent and one-off receipts, but with the figures as reported, the structural correction reduces to 0.3 per cent of GDP. Every 0.1 per cent of GDP next year is Rs 10,000 crore in absolute terms.
Of the 0.3 per cent structural correction, 0.17 per cent will come from additional revenue (without the one-off receipts, which have been flushed out to get the structural deficit). Expenditure reduction contributes 0.13 per cent. Yes, this is a revenue-led correction.
Some of the revenue moves are laudable, such as the doubling of import duty rates on gold. Smuggling networks have been largely dismantled over the last 20 years, and this hike is not large enough to motivate erstwhile smugglers to come out of retirement and put those networks together again.
The total expenditure correction is modest, but the capital expenditure component of it is budgeted to go up by 0.38 per cent of GDP including (and 0.26 per cent of GDP excluding) disinvestment-funded expenditure.
However, the content of what is called capital expenditure is a bit worrying. Starting last year, an effective revenue deficit was calculated, by removing from revenue (current) expenditure those grants going towards the creation of public capital assets. As an idea, I support it, and indeed did it myself in 2006 when reviewing public expenditure at the level of states (I called it an adjusted, not an effective revenue deficit). The spirit of the adjustment, however, requires removal of only capital expenditure on major public asset creation programmes funded through current grants. A legitimate example is the Pradhan Mantri Gram Sadak Yojana, which indeed is one of the big-ticket items. But getting capital asset creation mileage out of the entire expenditure on the Mahatma Gandhi National Rural Employment Guarantee Scheme is not defensible. This is a poverty alleviation scheme, only a small fraction of which - maybe 10 per cent - might result in enduring capital assets of any value.
Along with these two big schemes, the effective revenue deficit has been defined to exclude every scrap of capital content in revenue grants going to a large assortment of educational institutions. These may fund an auditorium or other such structure contributing nothing to the productive capacity of the economy. Plan transfers to states have also been bundled out, along with some statutory grants prescribed by the Finance Commission, but these certainly carry more justification. The justified elements add up to roughly half the total estimated capital expenditure content of revenue grants.
The exercise assumes importance in view of its hardwiring into the proposed amendment to the FRBM, which targets elimination of the effective revenue deficit by March 31, 2015, and caps the (total) revenue deficit on that date at two per cent, leaving an uncomfortably large margin for accommodation of infructuous capital expenditure of the auditorium variety.
The saving grace in the FRBM Amendment is the provision for review by the Comptroller and Auditor General of compliance with the provision of the Act, a much-needed element of external review which was missing in the original Act. That leaves room for continued monitoring of the quality of capital assets brought into existence through the grant route.
Even more than the quantum of public investment, there is need for focused attention on supply constraints in critical sectors of the economy. These include the dairy sector in the context of runaway inflation in milk; thermal power generation; and expansion of public transportation networks for goods and passengers, including last-mile connectivity, in light of the forthcoming correction of petroleum prices.