Fiscal developments and outlook in India

The paper identifies those elements in the configuration of fiscal parameters confronting the country that give cause for concern, and examines whether the fiscal reform measures taken address these adequately. The primary fiscal indicators consolidated across Central and state governments over the last fifty years, normalised by GDP and taken in first differences, are examined for evidence of countercyclical fiscal policy, and election-year profligacy. The underlying structural cause of fiscal stress since the start of reform in FY92 is then identified, as the uncompensated loss of trade tax revenues. This has led to a fall in the tax/GDP ratio, amounting by FY02 to two percent of GDP relative to the all-time peak of 16 percent achieved in FY90 (there is provisional evidence however of an upturn in FY03 by one percent). Finally, the two major fiscal reforms initiated in FY00 are examined. One is the accounting change whereby `small savings', a supply-driven automatic borrowing channel, were re-routed into a newly created National Small Savings Fund, independently of the budget. Although just an accounting change, it had a profound effect in terms of signalling the need for financial viability in the small savings scheme, and thus eroding embedded political economy pressures in the system that served to keep up interest rates. The second major reform is the fiscal responsibility legislation that has been enacted by the Centre, and four state governments so far. Simulated outcomes show that without an improvement in revenue effort, the required fiscal compression of non-interest revenue expenditure is so extreme that it could well result in political turbulence. That could then feed back through the election-year compulsions revealed in the regression analysis to worsening fiscal discipline again. The paper concludes that improved revenue effort is key to fiscal reform in India.