A former finance minister has, in response to an article by the current chairman of this newspaper that the 3 per cent fiscal deficit
target should be relaxed, written back that this can be done, provided the revenue deficit is eliminated and the excess of expenditure over revenue is invested, rather than consumed.
I have two problems with this response.
One is that Keynes made no such distinction and all deficit was for increasing consumption. That’s what he had meant by paying people for digging holes in the ground.
Second, while reductions in the revenue deficit increase political risk, increases in investment entail economic and business risk.
What the minister, for whom I have a lot of respect, has not explained is how this variance can be reconciled. The short answer is that it cannot.
Therefore to link the revenue deficit with the fiscal deficit
isn’t good policy. As we have seen since 2002, it will lead nowhere. Even if the revenue deficit is reduced by some accounting jugglery, as indeed it was about 13 years ago, it would be temporary.
This is because a large part of it comprises political payouts that are impossible to reduce in any significant measure. Indeed, on the contrary, minimising political risk means increasing the revenue deficit. This is the game all political parties have played since 1996 because of intense political competition between them.
In other words, in poor democracies, the revenue deficit is a given and it never comes down enough — if at all — to make a difference to the investment funds of the government.
A necessary delinking
This is the main reason why it is necessary to delink the fiscal deficit
from the revenue deficit and devise a way to ensure that the increment to the fiscal deficit from 3 to, say, 4 percent is only on account of investment expenditure. This should not be all that hard to do, provided basic commercial principles are followed for the new investments. If you look back, you will find that this is how the public sector was financed between 1955 and 1980.
Moreover, the fact that commercial principles had to be followed is what kept the deficits down. But this healthy practice was somewhat given up in the latter half of the 1980s. Then as political competition intensified in the 1990s it was discarded altogether, not least by Manmohan Singh, P Chidambaram
and Pranab Mukherji. This more-or-less fully explains the current fiscal crisis.
But now things have changed and political risk has vastly diminished. Mr Modi should, therefore, restore the old practices that governed investment expenditure of the government. He should tell the country and the global investors that he will increase the fiscal deficit but only to invest and further, that in those investments, purely commercial principles will be followed.
There remains the problem of separating the accounts. This is something the CAG
can be asked to figure out. Essentially it would require an accounting firewall like — guess what — the old plan and non-plan division! The only difference would be that half the plan expenditure would be financed by deficit financing.
Now I will sit back and wait for counter-argument for the sake of argument.