Though fiscal expansion did help combat economic slowdown, it cannot continue, says M Govinda Rao.

The expansionary fiscal stance of the last two years cannot continue and an exit strategy will have to be put in place in the forthcoming Budget to ensure fiscal sustainability and greater flexibility in monetary policy operation, and to enhance productivity in public spending and avoid pressure on interest rates.

Although not intended as fiscal stimulus, the unprecedented fiscal expansion during 2008-09 and 2009-10 did help in combating the economic slowdown, but it cannot continue and measures must be initiated to chart a route for fiscal consolidation.

The consolidated fiscal deficit, including off-Budget liabilities as a ratio of GDP in 2008-09 and 2009-10, is estimated at 10.4 per cent and 10.2 per cent, respectively, and the consolidated debt-GDP ratio is estimated at 76.6 per cent in 2009-10 as compared to 61 per cent in 1995-96 and 70.6 per cent in 2000-01.

The ratio of interest payments to own-revenue-receipts was 25.7 per cent for the Centre and 28.9 per cent for the states.  Therefore, it is necessary to initiate corrective measures as the economy recovers.

Indeed, the 13th Finance Commission will make detailed recommendations on the magnitude of correction to be achieved and the role of the Centre and the states in this task in the next five years.

Hopefully, the recommendations of the commission will also cover both the strategy as well as the road map for correction, including the magnitude of correction in revenue and expenditure sides and the mechanism to monitor the progress.

In the meantime, it is desirable for the central government to work on the adjustment strategy for the Budget of 2010-11. The strategy will have to be carefully crafted to ensure that the adjustment does not harm the green shoots and hamper the recovery process.

In particular, the adjustment process should not harm investments in infrastructure. Besides, with the ratio of revenue deficit to GDP estimated at 4.4 per cent in 2008-09 and 4.8 per cent in 2009-10, the large government dissaving will have to be reversed to increase the overall levels of saving and investment in the economy.

For initiating corrective measures, it is important to identify the revenue handles which can provide additional space and expenditure items that can be compressed without harming the recovery process.

In pursuing the exit strategy, two important features may be noted. First, much of the fiscal expansion has come about due to increase in expenditures and not tax cuts.

This implies that corrective measures must focus more on  adjusting expenditures as restoring tax cuts will not be sufficient. As a ratio of GDP, the combined impact of the reduction in economic growth and the tax cuts between 2007-08 and 2009-10 is estimated at 1.7 per cent of GDP (at the central level) -- and the reduction in revenues due to cuts in excise duty and service tax is not likely to be more than 0.5 per cent.

In contrast, Central expenditures as a ratio of GDP increased by more than 2.2 percentage points.  Second, expenditure stimulus has been in augmenting consumption and not investment.

While the increase in revenue expenditure since 2007-08 has been 2.6 percentage points, capital expenditure has actually declined by 0.4 point. Interestingly, even in the years of fiscal expansion, the Centre's capital expenditure as a ratio of GDP was 1.8 per cent in 2008-09 and 2.1 per cent in 2009-10, which were lower than 2.5 per cent in 2007-08.

A careful analysis shows that in the total Central plan outlay of 7.5 per cent of GDP in 2009-10, the budgetary contribution is only 53.5 per cent.

In fact, in many infrastructure sectors like coal, aviation, petroleum, power, roads and railways, the Budget contribution in plan outlay is estimated at just about 19 per cent and the remaining is expected to be mobilised from internal and extra-budgetary sources.

Thus, the stimulus has hardly augmented infrastructure spending and there is no scope for compressing it either.

There are some items of expenditure which are committed and, therefore, cannot be reduced. Interest payment and payment of salaries are two such items.

However, there can be substantial saving on salaries as pay arrears have already been disbursed. Indeed, the focus on austerity, despite its criticisms, could help contain expansion in the number of government employees.

Similarly, a substantial proportion of expenditure on loan waiver has been paid out. Pay arrears in 2008-09 amounted to Rs 16,883 crore (rs 168.83 billion), and with arrears of various autonomous bodies included, it could go up to Rs 20,000 crore (Rs 200 billion).

Similarly, it is estimated that over Rs 55,000 crore (Rs 550 billion) has been paid in 2008-09 and 2009-10, and the carry-over on this account may not be large. The saving on these two accounts, including slower employment growth, could be close to 0.5 per cent of GDP.

Similarly, if spending on various central schemes and subsidies is kept constant in absolute terms, it would decline by 0.5 per cent as a ratio of GDP.

This should be feasible; there are problems of utilising the allocation in most central schemes and, therefore, it should be useful to consolidate the implementation and accountability aspects before further expanding them.

Overall, it should be possible to reduce expenditure-GDP ratio by about 1 per cent without much difficulty.

On the revenue side, it is becoming clear that considerable preparatory work is needed before the GST reform is implemented, and the April 2010 deadline may not be realistic.

Nevertheless, the Central government can expand the base of the service tax and make it a general taxation of services, and unify the threshold and rate structure of CENVAT and service tax to make it GST at the manufacturing stage.

Once the expansion in the tax base includes productive tax bases like railway fares and freights, this could add to the revenue by about 0.5 per cent of GDP.

With extra revenues from disinvestment and telecom, it is possible to generate an additional revenue of 0.8 per cent. Thus, it is realistic to budget for a reduction in the fiscal deficit of the Centre from the budgeted 6.8 per cent in 2009-10 to 5 per cent in 2010-11 without any adverse impact on economic growth.

This would bring the momentum of fiscal correction back into focus, which is important and necessary at the present juncture.

The author is the director of National Institute of Public Finance and Policy. Views are personal