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Is our govt living beyond its means?
BS Bureau
 
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October 24, 2008

The Lok Sabha passed the supplementary grants demand amounting to over Rs 100,000 crore (Rs 1,000 billion)made by the government to enable it to meet various obligations ranging from the higher salary bill to funds to finance the farm loan waiver to issuing oil and fertiliser bonds to producers of these commodities.

All these commitments were expected to severely impact the state of the country's public finances, which, until last year, had improved considerably as a result of rapid growth in revenues.

A combination of timing (the Pay Commission), political compulsions (the loan waiver) and circumstances beyond the government's control (high energy prices) have contributed to a significant reversal of what was shaping up as a very healthy trend.

The Fiscal Responsibility and Budget Management Act, which mandates an end to the revenue deficit and permits a fiscal deficit up to a maximum of 3 per cent of GDP, which can only be used to finance capital expenditure, raised hopes that public spending would begin to address the widening gap in infrastructure, which poses a significant threat to the sustainability of growth.

However, given the developments of the past year, with the overall central government deficit likely to be around 6 per cent of GDP, these hopes must now necessarily recede.

Although the government refuses to treat the oil and fertiliser bonds as a part of the 'deficit' under the FRBM definition, few, if any, outside observers accept this position and there are rising concerns about the impact that the fiscal situation will have on macroeconomic stability and growth.

For a finance minister who swore by the FRBM targets, even getting into a very public spat with the Planning Commission over their criticality, this is a rather embarrassing way to end his term.

He can, of course, plead helplessness against the broader political compulsions that his government faced, not to mention the extremely volatile global situation, but it happened on his watch. His successor will face enormous challenges in getting things back on track.

Squeezing out resources for infrastructure development at a time when potential inflows into these sectors from abroad are likely to be severely constrained by the financial crisis will prove to be extremely difficult.

Even as Mr Chidambaram reassures us that the fundamentals of the economy remain sound, he has made his contribution to weakening them.

Of course, the pressure from oil prices and, sooner or later, from fertiliser prices as well has eased considerably giving the government some breathing space.

It can use it to begin retrieving the situation by not reducing the prices of petroleum products until it has redeemed the outstanding volume of bonds. But, here again, politics will most likely come into play and fiscal prudence will give way to populism.

A small proportion of the extra money, though, roughly Rs 3,000 crore (Rs 30 billion), may be well-spent. The government has decided to re-capitalise public sector banks to this extent with a view to enhancing their capacity to lend in these turbulent times.

Every bit of fresh liquidity in every form is needed to keep the system afloat and sustaining bank lending is a critical component.

Otherwise viable businesses are in danger of going under because they are starved of liquidity and this measure, though small, should do its bit to keep things going. The economy simply cannot afford a sick banking system.


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