Friday, 13 March 2015

End of Neo-Colonialism

The babel around the Budget and the XIV Finance Commission and subsequent comments and analyses have now ebbed. There are some States and stakeholders who are critical based on inadequacies of allocation in the social sector. But there is a consensus that the Budget represents a credible balancing act and gives a decisive momentum to the economic upturn which has already commenced. Thomas Sowell has said “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” So which lesson did the Budget pursue?

In retrospect, there were some overarching policy options to leverage that the Finance Minister had.

One, the classic choice: growth versus inflation. How much of fiscal flexibility was acceptable to enhance public outlays in infrastructure – railways and highways? The budget has adhered to the path of fiscal rectitude by meeting the fiscal deficit target of 4.1% this year.  It has postponed the terminal fiscal deficit target of 3% by an additional year with somewhat higher intermediate targets. The rating agencies prefer a closer adherence to the fiscal roadmap.  Of course the new time path must be adhered. I have for long argued that parliamentary approvals must be ex-ante than ex-post. The recommendation for a Fiscal Council contained in the Finance Commission’s recommendations is sensible.  This along with the new Monetary Policy Framework Agreement between the Finance Ministry and the Reserve Bank of India would act in congruent ways. It will ensure harmony between monetary and fiscal policy and thus Mint Street and North Block.

Two, subsidy rationalisation. There are significant gains in rationalising petroleum and fertilizer subsidies by de-regulating petrol and diesel and moving over to the Aadhar based LPG subsidy.  Further action is needed on fertilizers, particularly Urea. There must be pari-passu progress as JAM (Jan Dhan-Aadhar-Mobile) gathers momentum.

Three, congenial external environment to be harnessed. Oil prices have dramatically declined from $82 to $59 with soft commodity prices. The current account deficit is acceptable even though in the long run sluggish export behavior needs innovative action beyond conducive exchange rates.  We could have used this opportunity to create greater fiscal space for the future. Public debt could have been retired or a Consolidated Sinking Fund for amortisation of debt created. The Finance Commission suggests this can “tide over, roll over risks and the weak cash management practices.”. A middle path has been preferred. Substantial benefit has been passed to the consumers enhancing their purchasing power, allowing oil companies to recoup some losses and raise revenues to meet fiscal targets. Given the opportunity, this must be pursued.

Four, the XIV Finance Commission’s recommendations. There is overwhelming precedence that on devolutions they have been treated as awards than recommendatory. Consequently, total devolution to the States is now 62% of which 42% is from common divisible pool of taxes. The rise in tax devolution to States and the Non Plan grants to local bodies together represent a sharp cut of ’206292 crore from the Centre’s resource block. In the shrunken resources for the Central government the funding pattern of schemes has under gone a structural shift.  The Budget at a Glance again highlights the middle path. It classifies public outlays in three categories – schemes to be supported by the Union,  schemes to be continued with change in sharing pattern and those fully de-linked from Central support. The major flagship programmes of the government remain in the Union list like the Sarva Shikaha Abhiyan, MGNREGA, Pradhan Mantri Gram Sadak Yojna. There are others which would be financed with a changed sharing pattern. Schemes de-linked from Central support, leaving it for the States to decide are rather small. The most contentious being the Backward Region Grant Fund to Bihar, KBK and Bundelkhand.

There has been misplaced criticism that social sector outlays have been drastically pruned.  In making such comparisons a methodological error has crept in.  Analysts have compared the Budget Estimates of 2014-15 with the Budget Estimates for the current year. Those familiar with public finance know that normally the comparison is between the RE (Revised Estimates) with BE (Budget Estimates). Such comparison would suggest that allocations have been kept more or less intact. In the case of Integrated Child Development Scheme (ICDS) the reduction is sharp, but the pattern of funding is yet to be decided.

Thus the Budget and the Finance Commission are two sides of the same coin. It emanates from the design and conception of a new financial architecture of Centre-State relations. It is a giant step in promoting federalism where much larger untied resources become available to the States for selecting, designing and implementing programmes best suited to their needs. The Government had little option given the shrunken envelope after accepting the Finance Commission’s recommendations.  After all you cannot have the cake and also eat it. States cannot have both the cake of large untied resources and eat the Centrally Sponsored Schemes as originally conceived.  One can argue of whether this was the best approach or could the recalibration have been somewhat different? 

Will this new model of Fiscal Federalism work? There are inherent risks but also existing opportunities for Team India. The risks are well known if the State Governments act irresponsibly or promote fiscal profligacy. But in the end, the Government at the Centre and the States are judged by the improvement and development of life quality by the Electorate whose periodic mandate they seek.

The new fiscal architecture eliminates the form of neo-colonialism like what Rudyard Kipling described as the White Man’s Burden  viz. the Centre knows what was good for the States. A new social compact between the Union and the states has been ushered.

Thus, the adoption of the XIV Finance Commission’s recommendations and the Budget reflect that the Government has accepted both, the first lesson of economics and the first lesson of politics. A credible balancing act is what the budget is all about.

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