Budgetary Arithmetic Fiscal Imprudence and Macroeconomic Implications

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Economic and Political Weekly May 25, 2002 2081

Budgetary Arithmetic, Fiscal Imprudenceand Macroeconomic Implications

Notwithstanding the attempts made to undo the budget deficits initiating the fiscal reformprocess, the art of budget making in India is far from salutary both in terms of content, and

macroeconomic and social implications. Given the political economy fundamentals (institutionalconstraints), the adherence to fiscal rules may, at best, contain the overall public expenditures

through fiscal pruning measures, but may fail in addressing (i) the distributional effects of publicexpenditure policies, and hence, (ii) the composition of public expenditure.

is more worse, one step forward and halfa step backward fiscal consolidationmeasures proceeded altogether in thewrong direction with the axe falling on thegrowth and planned development-orienteddevelopment and capital expenditure withthe significant decline in public invest-ment in economic and social infrastructure.The recent budget 2001-2002, which came asa pleasant surprise for the euphoric privatecorporate sector, given the tax conces-sions, but it also reflected the same trend.2

Moreover, focusing on the fiscal disci-pline, the ways with which the final ag-gregate fiscal figures arrived at are of muchcause of concern, since they do not reflectany fundamental change in the structureof the fiscal deficit insofar as alteration ofthe composition of the fiscal deficit isconcerned. What then could be the plau-sible implications of such fiscal correc-tions, on long-run behaviour of theeconomy? In addition, do they entail largersocial implications in terms of social unrestand political costs, which might eventhreaten the very process of economicreforms? Why has it been an Achilles heelfor successive finance ministers, notwith-standing the general consensus on irrevo-cability of the reform process, and the need

for fiscal reform to achieve fiscal disci-pline through meaningful fiscal manage-ment, which is implicitly acting as a con-straint for pursuing other reform policies?3

An examination of these issues in essencewould point out to the inherent institu-tional constraints for implementing thecredible structural reform measures on thefiscal front.

This paper, in the following sectionoutlines a brief history reflecting theemergence of fiscal profligacy. And thenexamines the trends in the major fiscal

aggregates bringing out the imprudentnature of fiscal adjustment. Section IIIsurveys the macroeconomic and socialenvironment where the observations arefairly indicative of the present state ofIndian economy. Section IV, commentingon the political economy of budget, high-lights the institutional constraints. In theend, it argues that fiscal rules may not servethe purpose.

IIFiscal Slippage

Fiscal policy is an exercise of govern-ment to control public spending and taxa-tion to achieve broader economic objec-tives of stabilisation and growth. Againstthe failure of classical-monetary policy inthe 1930s, the Keynesian diagnosis ofdemand management stemmed the rot tocalibrate government spending and taxa-tion for generating income, employmentand output. Since then, active fiscal policyusing the instruments of taxation, publicborrowing and public expenditure, hasbecome a major tool to achieve desiredmacroeconomic goals. However, certainnecessary modifications were neededkeeping in tune with the peculiarities of

developing countries such as, sharp in-come equality, higher marginal propensityto consume and low savings (mostly inunproductive channels). Thus fiscal policyaimed at channelling these unproductivesavings into productive ones by the phi-losophy of tax the rich and spend on thepoor. The governments incurred expen-diture for the provision of economic andsocial overheads public utility services,banking and credit institutions, promotionof agriculture and (basic) industries.Governments made efforts to mobilise idle

IIntroduction

Following the political economydebate on deficit reduction, duringthe 1970s and 1980s, Latin America,

Europe and the US made serious effortsto bridge the gap between growing publicexpenditure and revenue. Not surprisingly,it is never been a cakewalk, as deficitreduction policies are always associatedwith politically sensitive charged issuessuch as, the retrenchment of labour, socialexpenditure cuts and trimming of large andinefficient bureaucracies following theretreat of overextended welfare state[Alesina et al 1998]. In India over twodecades of fiscal profligacy overheated theeconomy resulting in double-digit infla-tion, widening fiscal deficit and unsustain-able current account deficit; consequentlyerupting a macroeconomic crisis in mid-1991. Since then containing the fiscaldeficit, as an essential prerequisite for soundmacroeconomic management, is high onthe reform agenda.

Fiscal reform process became the centralfocus of the stabilisation-cum-structuraladjustment programme for achievingmacroeconomic stability in India. The

policy document outlined the need for thefiscal reform process to contain the deficitthrough various fiscal discipline measures.In the recent period, there is even a pro-posal for a constitutional cap on the fiscaldeficit (Fiscal Responsibility Act)1and theintroduction of zero-based budget. How-ever, so far, baring some piecemeal andad hoc measures, successive governmentsfailed to push through fiscal reform mea-sures against strong resistance from allquarters, despite oft-repeated proclama-tions for fiscal discipline [Rao 2000]. What

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resources (savings) effectively for capitalformation and reduction of income in-equalities. Therefore, fiscal policy clothedin the development character in additionto its objective of stabilisation and growth.

In India, since independence, given themixed economy set-up where the stateplayed a dominant role, fiscal policy hasevolved as an important macroeconomic

instrument to achieve national objective ofgrowth with equity. For the first twodecades, public finance was managedprudently with current revenue surpluseseven when government incurred signifi-cant investment expenditures as state-ledindustrialisation was in full swing. How-ever, subsequently widening resource gapswitnessed with record deficits. The rev-enue surplus which was accounted for oneper cent in the 1960s, one and halve percent in the 1970s, turned to a deficit ofhalve a per cent of the GDP in the early

1980s and 3.5 per cent in 1991. This re-flected in alarming fiscal deficit of 7 percent of GDP for the same year. Both failuresin revenue (tax) generation and expendi-ture control accounted for. More impor-tantly the deterioration of public financestarted with the shift in pattern (compo-sition) of public expenditure with theinstitutional (political) failure that wit-nessed the emergence of populist poli-cies [Joshi and Little 1998]. The deficitsgrew with the growing power of interestgroups, misappropriated susbsidies and

decaying public morality and corruption.As a general reflection, glaringly, duringthe 1980s economic growth was led byconsumption expenditure a direct contrastto the 1970s which was led by investmentexpenditure. Thus such an expansionaryconsumption-oriented fiscal policy over-heated the economy brewing a macroeco-nomic crisis in the mid-1990s; thus calledfor a meaningful deliberation of fiscaloperation.

The incidence of global changes coin-ciding with imminent domestic compul-

sions, borne out of prolonged macroeco-nomic mismanagement, courtesy fiscalprofligacy blowing macroeconomic fun-damentals to unsustainable levels, heraldedeconomic reforms under the flagship ofstabilisation-cum-structural adjustmentprogrammes. Waxing eloquently, thesemeasures rather compellingly substituteeconomic growth for poverty reduction, afull circle in the development of intellec-tual thought. The implicit argument is thata larger cake achieved by increased re-source and capacity utilisation, a resultant

of enhanced efficiency and productivity,is an essential prerequisite for percolationof benefits with fair distribution. For that,a competitive environment as a spring-board for larger and efficient private par-ticipation must be followed by curtailmentof inefficient resource use by the state.Precisely towards these ends, the conse-quent budgets followed by successive fi-

nance ministers heroically made attemptsto undo the archetypical monotonic bud-gets of deficit initiating the fiscal reformprocess. The fiscal reform measures aimedat reduction of budget deficit through ex-penditure controls elimination ofmonetisation of deficits, progressive re-duction of subsidies and closure of sickpublic sector units (PSUs), and revenuegeneration through greater tax compliancewith tax reforms reduction andrationalisation of tax rates (EconomicSurvey, various years). Despite the efforts,

however, this process met with very littlesuccess either in containing unproductiveconsumption expenditure or in revenuegeneration. Thus the nature of fiscal cor-rection through fiscal pruning underscoredthe lack of credibility of the fiscal reformprogramme and the art of budget-makingis far from optimal both in terms of con-tent, and macroeconomic and socialimplications.

Successive budgets received prematureapplause with fiscal authority failing toshow fiscal marksmanship, except for the

year 2000-01, since the initiation of re-forms. All these years the ex ante budgetestimated figures far diverged from the expost actual revenues falling short andexpenditures exceeding the targets (see

Economic Survey, various years). Secondly,the structural composition of the fiscaldeficit remained unchanged since succes-sive budgets has not recorded any signifi-cant qualitative change. In essence, thegrowth-oriented character of the budgetis still elusive due to imprudent fiscaladjustments. The examination in the

trends of major fiscal aggregates entails.Therefore, even when the fiscal deficit

as a per cent of GDP declined from 6.6in 1990-91 to 5.1 in 2000-01, with thedeclining total government expenditurefrom 17.3 to 15.3, the consumption expen-diture increased from 6.3 to 6.4 for thesame period. Consequently, the revenuedeficit increased from 3.3 in 1990-91 to

3.6 in 2000-01. However, the axe fellcontinuously on capital expenditure. Thecapital expenditure perceptibly declinedfrom 4.4 per cent of GDP in 1990-91 to2.4 in 2000-01. The primary deficit invest-ment from 1.7 per cent in 1990-91 turnedto a negative of 0.1 in 2000-01.4Even forthe passing year 2000-01 the final figuresfor fiscal deficit could be achieved notbecause of any alteration of composition compressing revenue expenditure evento the targeted level or increasing capitalexpenditure, for which all the tall claims

have been made. The capital expenditurefell short from the targeted 2.6 per centof GDP by 0.2 per cent. The revenueexpenditure totalling Rs 2,84,000 croreexceeded the targeted level to the tune ofRs 3,000 crore whereas capital expendi-ture on plan account fell by Rs 5,402 croreresulting in around 10 per cent cut in thecentral plan outlay. Therefore, revisedcapital expenditure figures over budgetedon economic and social services agricul-ture, rural development, infrastructure,health, social security, so on and so forth,

registered a negative. For the next year alsothe targeted plan capital expenditure ofRs 5,000 crore is directly tied to the suc-cess of disinvestment proceeds of esti-mated Rs 12,000 crore. But having seenthe experience with the pace of disinvest-ment programme in the recent, it wouldappear to be nothing less than a wishfulthinking. More worrisome fact is that Rs77,000 crore constituting over 70 per centof the borrowings goes in mitigating un-productive expenditure. The increase inoverall deficit is also due to less success

Table 1: Selected Fiscal Aggregates*(As Per Cent of GDP at Market Prices)

Fiscal indicators 1990- 1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000-

91 92 93 94 95 96 97 98 99 2000 2001

Fiscal deficit 6.6 4.7 4.8 6.4 4.8 4.3 4.1 4.8 5.1 5.4 5.1Revenue deficit 3.3 2.6 2.5 3.8 3.1 2.5 2.4 3.1 3.7 3.5 3.6Total expenditure 17.3 16.2 15.8 15.9 14.9 14.2 13.9 14.2 14.5 15.2 15.3

Consumption expenditure 6.3 6.0 6.3 6.5 6.2 5.9 5.6 5.9 6.2 6.5 6.4

Capital expenditure 4.4 3.6 3.4 3.3 2.9 2.4 2.3 2.4 2.2 2.5 2.4Net tax

revenues 7.6 7.7 7.2 6.2 6.7 6.9 6.8 6.3 5.9 6.5 6.6

Note: * All fiscal aggregates relates to central government.Source: Economic Survey1999-2000 and 2000-2001.


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in resource generation. The revenue receiptsas a per cent of GDP declined from 9.7in 1990-91 to 9.3 in 2000-01. Net taxrevenue of the central government as a percent of GDP declined from 7.6 per centin 1990-91 to 6.6 per cent in 2000-01mainly because of a significant fall inindirect taxes (customs and excise), whichare not compensated by the rise in direct

taxes. Against the constrained revenuegeneration, fiscal adjustment was madethrough cutting down public investmentactivities across the board. The real grossdomestic capital formation of the publicsector as a per cent of GDP witnesseda significant fall from 9.7 in 1990-91to 6.8 in 1999-00.

The situation at the state level is moreprecarious as the major fiscal indicatorsreflect. The fiscal deficit as a per cent ofstate domestic product (SDP) increasedsubstantially from 2.9 in 1990-91 to 4.1

in 1999-00 with equally matching rise inthe revenue deficit from 0.9 to 2.1, whereasrevenue receipts declined from 11.7 to11.2. The rise in expenditure can be seenthrough the change in political environ-ment with the rise in regional politicalparties that followed political populism.Consequently, the development expendi-ture as a per cent of SDP declined from11.1 in 1990-91 to 9.6 in 2001. On the revenueside, apart from the existing mode of sharingof tax revenues and multilayered tax sys-tems, recently states following competi-

tive populism went all out in giving taxconcessions to attract foreign invest-ment ignoring long-term implications.

The efficacy of public expenditure canbe gauged from its nature of utilisation.In other words, fiscal discipline is achievedonly when cut in non-developmental cur-rent consumption expenditure makes forfiscal adjustment. In contrast as can be seenthe adjustment leaves much to be desired.

Consequently the immediate fallout ofsuch fiscal adjustment has been, as can beseen from Table 2, on development expen-

diture, which as a per cent of GDP fell from10.3 per cent in 1990-91 to 6.2 per centin 2000-01. So also plan outlay and planexpenditure fell from 6.6 and 4.9 to 5.0and 4.0 as per cent of GDP for the sameyears, respectively. These developmentsreinforce the point that the nature of fiscalcorrection belies fiscal discipline, how-ever defined and would have definitemedium- and long-term implications forthe growth process. In what follows is adiscussion on macroeconomic and socialenvironment.

IIIEquilibrium Recession

In modern macro-economic parlance, thecurrent macroeconomic environment inIndia, reading through the macroeconomicparameters high real interest rates, lowcapital investment and low share values,would be termed as an equilibrium reces-

sion or low output equilibrium [Frank1995]. This is an equilibrium since lowoutput and resulting low income lead tolow savings that match low investment.Real GDP growth down from 6.4 per centin 1999-00 to 6.0 per cent in 2000-01 dueto fall in growth in agricultural productionfrom 2.7 per cent to -3.5 per cent andindustrial production from 6.5 per cent to5.7 per cent. The sectoral analysis showsthat the service sector growth also felldown from 9.6 per cent to 8.3 per cent.Gross domestic savings and investment

are stagnating at just over 22 and 23 percent correspondingly. The low growth of2.1 per cent in non-POL imports comparedto an increase of 8 per cent in the previousyear reflects a weak domestic demand andsubdued industrial activity. The thirdquarter (Q3) (for 2000-01) bank creditdipped by Rs 10,000 crore for the lack ofcorporate demand. The manufacturingsector reeling under a recession as Q3automobiles sector growth fell by 13.4 percent. Recently inflation raised its head to8.3 per cent backed by 17.7 per cent in-

flation in electricity, gas and water supplycomponent after a prolonged period ofsustained decline. Real interest rates re-mained high at around 9 per cent. Theeconomy is tottering under a severe effec-tive aggregate demand with a subduedmarket. The slide in the private corporatesectors gross domestic capital formationcontinued as it declined as a per cent ofGDP from 8.0 to 7.9. Growth in privatefinal consumption expenditure also fellfrom 7.2 per cent to 4.1 per cent.

These developments are a continuation

of the turnaround in the performance ofthe Indian economy since the mid 1990s

as growth in all the constituent sectorsreceded. As can be seen from Table 3, bothagricultural and industrial growth hasfaltered. For last couple of years the ser-vice sector growth was also moderate. Thefall in the organised public sector employ-ment to a negative rate of growth has notbeen compensated by the private sectorabsorption of labour. With the declining

rates of capital formation, savings andinvestment rates as a per cent of GDP fellfrom 24.3 and 27.7 in 1990-91 to 22.3 and23.3 in 1999-00, respectively. The growthin the economy has slowed down. Recentresearch also provides evidences pointingout the adverse income distribution withthe arrest in the reduction of rural poverty worsening income equality, employmentand quality of farm and non-farm employ-ment, fall in real income (wages) andincrease in casualisation and migration[Nagarj 2000, Panchamukhi 2000 and

Ravallion 2000].5Therefore, both growthand distributional fallout has been re-corded. In turn these developments fedback into the budget deficits since theelastic revenues fell steeply in the down-turn against pre-committed rigid expendi-tures.6

IVPolitical Economy of Budget

Making

The forgoing analysis clearly brings out

the imprudent fiscal adjustment process inIndia. Controlling overall public expendi-ture remained the preoccupation to containthe fiscal deficit overlooking the compo-sition of it. Therefore, misguidedly, fiscaldeficit, rather than revenue deficit, becamethe focus of attention. The politicaleconomy of budget making paraded by thepowerful interest groups stall the introduc-tion of any efficiency enhancing measures,virtually forced successive governmentsto accommodate the historical drag of dra-conian fiscal deficits; being unable to wipe

out consumption expenditure. Therefore,the revenue deficit, which had shown a

Table 2: Major Expenditure Heads(As Per Cent of GDP at Market Prices)

Types of Expenditure 1990- 1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000-91 92 93 94 95 96 97 98 99 2000 2001

DevelopmentExpenditure 10.3 9.1 8.7 8.4 8.2 7.1 6.9 7.3 7.8 6.8 6.2Social services and

Poverty Alleviation 0.6 0.5 0.5 0.6 0.6 0.6 0.7 0.8 0.8 0.9 0.8

Plant outlay 6.6 7.0 6.9 6.3 6.4 5.3 5.0 4.7 5.0

Plan expenditure 5.0 4.9 4.9 5.1 4.7 3.9 3.9 3.9 3.8 3.9 4.0

Source:Economic Survey1999-2000 and 2000-2001.


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declining trend, once again widened. Forstabilisation to be complemented by struc-tural adjustment measures, one would haveexpected an increase in public investmentto offset the contractionary impact of fiscalretrenchment giving a qualitative changeto the fiscal adjustment. But on the con-trary, shortsighted policies biased in favourof consumption expenditure at the cost of

investment cuts came at a high price offaltering economic growth. Whatever mod-erate success has been achieved in thefiscal adjustment process is through indis-criminate cuts in the capital expenditureand public investment downplaying thestate role in inducing investment activities.Consequently, no tangency between thewithdrawal of the public sector and theentry of the private sector has been no-ticed. As a result productive sectors suchas, agriculture and industry starved offresources.7

While the total public expenditure camedown sharply, the redistributive aspect offiscal expenditures was nullified in theabsence of qualitative alteration in the com-position of public expenditure. Given thepolitical economy of budget-making, publicexpenditure was tuned to the weight of theinterest groups as reflected by the sharpfall in plan development (and social)expenditures. In addition, budgets mis-directedly squeezed allocated resourcesacross the board, thereby depriving thecommon man of his accustomed benefits,

to cover-up deficits rather than making anyconcerted effort to improve functionalefficiency for channelling resources effec-tively to the target groups.

On the other hand, protagonists of re-forms vehemently argued for tax cuts.8

Tax cuts are offered even when one hasnot witnessed the Laffer curve effect agreater compliance by the reduction of taxrates yielding higher revenues. Again, thelack of buoyancy in tax reforms is due tothe lack of institutional (administrativeinefficiency) improvements. Besides, it is

yet remains to be seen whether corporatetax cuts based on the supply side econom-ics that tax cuts quickly revives the economythrough productivity gains has any foun-dation. In the post reform phase the privatecorporate sector has not respondedfavourably in bringing in long-term effi-ciency through R and D and in-housetechnology generation [Basant 2000].Therefore, the structural and institutional(political) factors are acting as constraintsin the redistributive efforts of publicexpenditure.

VPolicy Imperative

Taking a leaf from the experiences ofdeveloped and developing countries andbased upon the emphasis on the qualitativeaspects of economic growth, there is grow-ing convergence in the view that incomedistribution influences economic growth

insofar as the level of income inequalityand hence poverty adversely affect eco-nomic growth. Moreover, this fresh per-spective contends that there is no trade-off between redistributive and efficiencygoals in public expenditure policies. There-fore, economic policies including budget-ary policies having strong distributionaleffects are favourable [Schwartz and Teresa2000]. Specifically, formerly centrallyplanned economies in the transition fromplan to market witnessed worsening dis-tributional consequences reflecting an

increase in poverty. Therefore, public ex-penditures potentially having redistribu-tive effects are sought for. Indeed, histori-cally, big governments through publicexpenditure played an important stabilisingrole in moderating economic fluctuations[Minsky 1986]. The usual investmentmultipliers helped in generating incomeand employment. Such expenditure, how-ever, must qualify a big qualitativecondition since income distribution de-pends on the composition of public expen-diture policies. It must be productive public

investment in economic and social infra-structure which is growth enhancing as itcrowds-in private investment.

In India, what matters the most is invest-ment in rural infrastructure and socialservices. Moreover, since the recent Bud-get 2001-02 introduced flexible contractsin the context of labour laws, that aim forsubcontracting and outsourcing togetherwith dereservation of some small-scaleindustries, may inflict short-run adjust-

ment problems by putting upward pressurein the organised labour market. For that,measures such as credit delivery, rural in-frastructure creation food for work pro-grammes, and social security measures(health care and education) must be ex-ecuted unfailingly. For a labour surpluscountry like India where inequality andpoverty are predominant, employment and

income generation must be the primeconsideration for any policy to succeed inthe long-run. Public expenditure in termsof public investment will play not only acrucial role for a rising employment andincome generation but also sharing theirbenefits across all groups. Broadening theconstituency of public expenditure will ineffect solve the political economy prob-lem. Fiscal prudence is not just contain-ment of public expenditure but impor-tantly altering the pattern of public expen-diture in terms of public investment and

a more productive use so as to supplementthe private sector in crowding in the pri-vate sector to boost the economic activity.

Macroeconomic policy-making is an artas much as science. Economic cycles,economic downturns and upturns, call fordifferent sets of appropriate fiscal andmonetary policy measures to pull andpush the economy, without drifting from,or being inconsistent with, long-termobjectives of growth with development.Since central banks are powered to containaggregate demand through restrictive

monetary policy but not in reversing it,they can only pull but not push theeconomy. Therefore, in the downturn theonus squarely falls on fiscal policy as acounter-cyclical tool in pushing theeconomy to a higher equilibrium growthpath. The present macroeconomic pictureis the gloomiest one in the post-reformphase, born out of an imminent slowdownin the domestic economy. Growth inalmost all the constituent sectors has

Table 3: Selected Macroeconomic Aggregates(in Per Cent)

Indicators 1990- 1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000-

91 92 93 94 95 96 97 98 99 2000 2001Growth Rates

GDP 5.4 0.8 5.3 6.2 7.0 7.3 7.5 5.0 6.8 6.4 6.0

Agricultural production 3.8 1.9 4.2 3.8 5.1 2.7 9.3 6.1 8.1 2.6 3.5Industrial production 8.2 0.6 2.3 5.6 8.4 12.8 5.6 6.6 4.0 6.2 5.7

Employment 1.4 1.2 0.4 0.7 0.6 1.5 1.1 0.3 0.1

Public sector 1.5 0.8 0.6 0.6 0.2 0.2 0.7 0.7 0.0

Private Sector 1.2 0.2 0.1 1.0 1.6 5.6 2.1 0.3 0.1 Ratios

Savings rate * 24.3 22.9 22 22.5 25.0 25.1 23.2 23.5 22.0 22.3 Investment rate * 27.7 23.4 23.9 23.1 26.1 26.8 24.5 25.0 23.0 23.3

Note:* Savings and investment rates are as a proportion of GDP.Source: Economic Survey 1999-2000 and 2000-2001.


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bottomed out, aggregate demand has per-ceptibly declined, there have been large-scale losses due to unforeseen natural ca-lamities and high fiscal deficit coupledwith external adverse developments highoil prices, slowdown of the US economyand declining capital flows. As the Eco-nomic Survey 2000-01pointed out a de-mand augmented stimulation to growth is

needed. Moreover, from a medium- andlong-term perspective, what are necessaryare liberal policy measures that would freethe economy from the shackles of rigidi-ties, institutional or structural, which wouldfacilitate both (i) utilisation of idle capa-city, and (ii) enhancement of productivecapacity through efficiency gains. In thisgiven scenario, fiscal policy along withmonetary policy can act as a demandmanagement tool.

In this context, the Fiscal ResponsibilityAct needs a critical look. The introduction

appears to be motivated on the grounds ofsustainability (of public debt) andintertemporal equity issue associated withdiscretionary fiscal action. The act can beseen as economic constitutionalism thatintends to impose stricter economic dis-cipline on economic decision-makers forthe lack of credibility in the past. However,the pertinent question is whether economicpolicy should be subject to normative rulesor strict legal constraints as the use of rigidrules perhaps could be a second-bestsolution to stabilise the economy [Tobin

1983]. Given the political economy fun-damentals in India, it may at best containthe overall public expenditures throughfiscal pruning measures, but may fail toaddress (1) the distributional effects ofpublic expenditure policies, and hence(2) the composition of public expenditure.From macroeconomic perspective, theinstability in the demand for money andthe ambiguous relationship between inter-est rates and output, such deficitism fora balanced budget as a cure for higherinterest rates, inflation and an overextended

state seems to be a highly imperfect instru-ment for controlling economy activity. Dis-cretionary fiscal policy still can play anactive role through the changes in govern-ment spending, income transfers and in-direct tax changes [Wren-Lewis 2000].After all the fiscal responsibility act is ameans to an end of achieving fiscal dis-cipline. The objective is to increase theinstitutional efficiency for devising cost-effective, efficient and equitable policies.For that, a perceptible change in the in-stitutional setting must be seen through.

Policies themselves do not matter if notfor guiding interacting agents to generatebetter economic and social equilibria. Thebasic thrust should not be just containingthe fiscal deficit but altering the compo-sition of the fiscal deficit to ensure macro-economic stability and growth. Tinkeringwith macroeconomic parameters, whichare increasingly endogenously determined

in the system, will not work. Since thesemacroeconomic parameters are state de-pendent variables, they are reproduced bythe system and no longer can be imposedas constraints on the system. Therefore, abetter institutional environment by itselfwould ensure reproduction of good statesof the world.

Notes

[Thanks are due to Romar Correa for his editorialcomments on an earlier version]

1 For medium term management of the fiscaldeficit the budget proposed the FiscalResponsibility Act with the introduction of theFiscal Responsibility and BudgetManagement Bill, 2000, in Lok Sabha (lowerhouse of the parliament) in December 2000.The proposed legislation provides for a legaland institutional framework to eliminaterevenue deficit, bring down the fiscal deficit,contain the growth of public debt and stabilisedebt as a proportion of GDP within a timeframe. For more details see, Ministry of Finance(2000).

2 Of course, for the first time in the post-reformperiod, the Budget 2001-02 announced some

bold structural measures such as, downsizingthe government, dereservation of small-scalesectors, flexible contract in the context oflabour laws and decontrolling prices of sugar,fertiliser and drugs. But as will be argued,leaving aside their utility, given the institutionalconstraints, their successful implementationyet remains to be seen.

3 For instance, financial sector reforms are notlikely to succeed both in terms of their contentand speed with such failure.

4 The data not presented in the tables, butmentioned throughout the text, however, relatesto the same source.

5 The National Sample Survey (NSS) estimates,however debatable on the statistical ground,

reported that rural poverty rose to 38.6 per centand unemployment levels remained stagnant[Rao 2000].

6 Being taxes procyclical and public expenditureacyclical, the fiscal deficit moves in a counter-cyclical fashion.

7 A critical review of performance of the Indianeconomy in the post-reform phase has shownthat with the state retreating from investmentactivities, the economy lost stimulus. Theprivate sector initiative in agriculture andindustry found wanting [Rao 2001].

8 In fact, in the recent years the trend has beenthat the barometer for judging the budgetturned out to be announcement of lowering

of tax rates and tax concessions, for which thebudgets are applauded or punished. Forinstance, this year jubilation is precisely forthe announcement of tax concessions, in spiteof the fact that the targeted fiscal figures arearrived through curtai l ing capi talexpenditure, whereas in the last year budgetreceived with utter dismay since it did notcontain any tax concessions. The sharp upwardand downswing of stock prices in the pre- andpost-budget presentation reflects thissentiment.

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Budgetary Arithmetic Fiscal Imprudence and Macroeconomic Implications