After Iceland it is now Greece. An important difference is that the Iceland episode was the result of instability of its banks and financial institutions. The economic turbulence in Greece was triggered by a deep fiscal crisis. Its public debt stock amounting to 115 per cent of gross domestic product (GDP) is likely to rise to 150 per cent by 2014.

This was driven by a growing fiscal deficit and a declining GDP. Fiscal deficit is adding 14 per cent of GDP annually to the debt stock though GDP itself is declining by 4-5 per cent a year.

Greece's debt crisis has led to instability in the European Union's common currency, the euro. There are fears of public debt crises spreading to other EU member states. European leaders have announced a $1 trillion bailout package in collaboration with the International Monetary Fund. EU finance ministers have pledged to tighten penalties on countries with runaway fiscal deficits.

Limited impact on India

India's Finance Minister and the Reserve Bank Governor have stated that the impact of the European developments on India will be limited. On the fiscal front, the 2010-11 budget estimates a fiscal deficit of Rs. 381,408 crore or 5.5 per cent of the GDP. The Government's public debt at the end of the year is projected at Rs. 2,898,798 crore or 42 per cent of the GDP. The external debt is placed at less than 5 per cent of the public debt.

Apart from the comparatively low budget deficit projections and overall total public debt data, there are some positive steps taken by the government in the fiscal area. The need to contain fiscal deficit and borrowing has been accepted. Also recognised is the importance of medium-term fiscal sustainability while preparing the annual budget.

The Constitution provides for Parliament putting a ceiling on public debt though no such law has been passed till now. However, legislation in the form of Fiscal Responsibility and Budget Management Act (FRBM Act) was introduced in 2003 to curb budgetary deficits. This historic legislation stipulated abolition of revenue deficit in five years and reduction of fiscal deficit to 3 per cent of GDP.

While there is no need to push the fiscal panic button, it is but prudent to use this occasion to take note of a few shortcomings in pursuing the medium-term fiscal approach. First, there is too much preoccupation with quantitative targets for deficits and debt servicing burdens as percentages of GDP.

Achieving targets is no doubt important. Credit is being taken for fiscal consolidation on the basis of conforming to the revenue and fiscal deficits in the FRBM Act 2003 (with a modified time schedule in the context of fiscal stimulus). But what has been overlooked is the way this has been achieved. Even the Finance Minister has conceded that the fiscal improvement has been revenue-driven, helped by buoyancy in revenue in recent years.

This is all the more so in the 2010-11 budget which has assumed Rs. 40,000 crore from disinvestment in public sector undertakings and sizable proceeds from auction of 3G spectrum (Actual proceeds of nearly Rs. 70,000 crore from the recent auctions amount to more than double the budget estimate.) An unfortunate result has been neglect of urgently needed reform in major areas of revenue and expenditure, which alone can lead to real long-term fiscal health. The focus has to be on how to reduce deficit and not merely on how much to show target achievement.

Areas for action

The specific areas for immediate action are many. A few of them can be cited — major subsidies (more than Rs. 1 lakh crore each year), vast bureaucracy (3.36 million, excluding the armed forces and costing Rs. 60,000 crore), proliferation of functions in ministries and departments, overlapping schemes, cost and time overruns in projects, effectiveness of public expenditure, burden of PSUs on the budget, sick and cash-loss PSUs, cross-subsidy of railway fares by freight and revenue foregone through tax exemptions (Rs. 5 lakh crore each year). Reform action should address policy and implementation issues.

Again, a few examples readily come to mind — dismantling of administrative price mechanism in petroleum products, procurement price policy for foodgrains, review and discontinuance of functions not relevant to government, outsourcing functions, rational allocation of scarce resources among competing priorities (Plan / non-Plan classification distorts the picture), efficiency of public distribution system, making output-outcome budgeting an effective management tool, privatising PSUs no longer in the current list of areas fit for governmental operation, and winding up sick PSUs.

A realistic medium-term projection of revenue, expenditure and deficits for three years needs to be drawn up incorporating data based on action plan to implement specific reforms. Numerous reports of commissions, committees and task forces are pending review and no new committees need be set up. What is required is a time-bound action plan whose progress is closely watched and placed before Parliament and the public.

Enforcement of reform-oriented medium-term fiscal projections has to be done by State governments also. The Central Government has to use its leverage in this area.

Public debt sustainability will help a combined approach with monetary policy. It will sustain foreign investors' confidence and facilitate inflow of foreign direct investment.

It may be mentioned that the new coalition government in the U.K. has announced a massive spending-cut programme presumably as a pre-emptive measure to avoid a fiscal crisis.

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