Fiscal consolidation: Addressing policy dilemma

April 26, 2018

Krishna Sharma, The Himalayan Times, 26 April 2018

Fiscal prudence can increase credibility and create confidence among investors, especially among foreign investors who are becoming more critical in an increasingly financially integrated world

The National Planning Commission, like always, recently came up with the guidelines for upcoming budget which entails detailed suggestions such as fixing the budget ceiling, projecting the income sources and specifying the limit on the expenditure. The guidelines, notably this time, have recommended the priority sector for spending the centre and provinces. At a glance, the document seems promising with readymade tools for the centre and provinces for their fiscal policies. However, it falls short of any detailed forecasting and financial indicators.

The guidelines could have attempted to look at the fiscal-sustainability aspect through an in-depth study of sustainability of income sources and quality of expenditure (revenue and capital expenditure) to realise the benefits of fiscal consolidation roadmap. There is hence the likelihood of this document once again becoming a ritual, and the government may carry out its business as usual.

Nepal’s current economic scenario is vulnerable. The country has recently got into the federal structure and all the provinces have come up with their plans and policies. On top of that, the country is still struggling to cope with the losses caused by two major shocks: the decade-long armed conflict (1996-2006) and earthquakes (2015).

The country is still in transition, just as it looks with optimism at political stability.  Nepal’ infrastructure projects have been pending and delayed for long. The government at the centre and provincial and local governments have the humongous task of meeting the expectations of the people as the whole electoral campaign was based on delivery on development. Thus, governments at all levels might end up formulating their fiscal policies in an exuberant mood, which can lead the economy to crisis.

The fixing of budget ceiling and specifying the limit for revenue expenditure and capital expenditure are certainly a good move as it takes our approach away from discretionary-based to rule-based.

Even though the NPC has not come up with goals of setting the target for fiscal deficit and revenue deficit, this is a welcome step in aligning the government with some degree of fiscal responsibilities.

For the upcoming central budget, the NPC has set the budget ceiling at Rs 1,200 billion. Out of this, the NPC has 62.3 per cent and 25.5 per cent targets for recurrent and capital expenditures respectively. But this doesn’t necessarily enable the government to adhere to the fiscal discipline.

There is enough space for perturbations as the proposed budgetary plan is still not able to put more weight on the capital expenditure. The fiscal deficit for the country is driven by the revenue deficit (excess of revenue expenditure over revenue collection) over the decades, and the similar story unfolds in the NPC’s projection. This is definitely not according to the golden rule specified for fiscal policies for developing economies.

The British economist, John Maynard Keynes, argues that as long as the government spends on building assets there is no need to worry about the deficit because of positive spillover effect. The study of Indian economy also shows that multiplier effect from the capital expenditure seems much higher as compared to revenue expenditure in an economy, so the former should be encouraged especially when the country is in the dire need of uplifting the basic infrastructure level.

Realising the importance of quality of spending, majority of policymakers in India are putting forward the argument that revenue deficit should be brought down to zero in coming years. This was also one of key recommendations of Fiscal Responsibility and Budget Management, (FRBM) Act, 2003.

In the context of the significance of fiscal prudence, one should not forget the bitter history of India’s 1991 crisis, where the government was not even able to pay even for two weeks of imports. Consequently, economic reforms were introduced that year in which fiscal consolidation had been made the critical area of reforms. On the bright side, India was able to cope with the global financial crisis of 2008 because of its strict adherence to the path of fiscal consolidation during the pre-crisis period, which had created enough fiscal space for India to pursue the countercyclical fiscal policy during and after financial crisis.

The maxim that “you cannot spend your way to prosperity” is now highly realised all over, especially after the breakdown of the global economy in 2008. Therefore, majority of governments came to consensus that fiscal policies of the government should not be rooted in exuberance.

Thus, it is widely accepted in emerging economies that fiscal policies need a balance between growth compulsions and macroeconomic stabilisation. These are not easy choices to make.  In this regard, the NPC might consider preparing a detailed road map through the inclusion of target for major fiscal indicators such as fiscal deficit, revenue deficit and public debt-GDP ratio, in addition to recently issued guidelines. This would be the effective ready reckoner for pursuing the path of fiscal consolidation — both for the centre and provinces.

Fiscal prudence can increase credibility and create confidence among investors, especially among foreign investors who are becoming more critical in an increasingly financially integrated world.

Sharma is a consultant at National Institute of Public Finance and Policy, New Delhi