Rationality in Fiscal policy

What is the issue?

India has to set up proper institutional apparatus to bring rationality in the budgetary process and fiscal policy.

What are the challenges to the fiscal policy?

The budgetary process and fiscal policy in India face two big problems.
The first is the mismeasurement of GDP and potentially its over-estimation.
This has important consequences for tax targets and the bond issuance programme.
The second is the emergence of population-scale entitlement programmes.
These have induced adverse effects upon the political economy worldwide.
Thus, India will need to build the countervailing forces to check and balance the political imperative.

What are the implications of an unreliable GDP estimates?

GDP data has direct consequences for budget-making, since tax targets in each budget process are made upon the GDP projections.
Thus, errors in GDP estimation induce errors in the tax targets.
The tax revenue for 2018-19 was 7.9% of GDP, and the tax target for 2019-20 has been set to 8.1% of GDP.
However, there are important errors in GDP estimation.
Some independent data sources such as corporate sales, corporate profits, private investment suggest that the official GDP data is over-estimated.
As an example, from 2014-15 to 2017-18 (three years), nominal GDP went up by 37% but the nominal net sales of nearly 5,019 non-oil, non-finance companies went up by 22%.
Also if GDP is over-estimated, the government will set high tax targets.
This will force the tax inspectors to comply with the stipulated targets, which will become a source of stress for the economy.
The bond issuance programme are also affected by mismeasurement of GDP.
If GDP is over-estimated, the magnitude of bond sales is too large, compared with what the economy can absorb.

What are the concerns with fiscal spending?

Therecent concern in public finance is the rise of population-scale entitlement programmes.
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.
A positive net present value indicates that the projected earnings generated by a project or investment exceeds the anticipated costs.
For many of the schemes in India, the NPV was not computed or analysed before it was getting approved.
These entitlement programmes are getting more and more based on a projected expenditure for next year and not on long-term projections.
Thus, the government should make sure that these programmes be approved only after comparing the short-term political gains versus the NPV over a long-term.

What should be done?

The government can keep the debt on track even when GDP is mismeasured.
Primary deficit refers to difference between fiscal deficit of the current year and interest payments on the previous borrowings. [Primary Deficit = Fiscal Deficit – Interest Payments]
It indicates, how much of the government borrowings are going to meet expenses other than the interest payments.
If the government run a primary surplus, it is paying down debtand lowering its debt-GDP ratio, without even knowing the correct GDP estimates.
Thus, it would be prudent for fiscal policy makers in our data-poor environment to use such a rule.
This would protect us from the possibility of faulty fiscal policy calculations flowing from faulty GDP estimates.
Also, it is essential to build the institutional apparatus through which debt-management decisions could be made.
These include -

A reliable GDP measurement
Strengthening of bond market
Setting up a full-fledged independent public debt management agencyto manage government borrowing programme
Establishing the Fiscal Councilto advise and assess government's spending and fiscal policy

Source: Business Standard