Context: With the scale of GDP contraction due to the Covid-19 pandemic now confirmed, the urgency of providing immediate relief to the most affected citizens and states has risen.

Fiscal marksmanship in India: undertaken with a clever rearrangement of government expenditures or financing from - 

• ‘Above the line’ to ‘Below the line’: Recapitalising public sector banks with bonds rather than outright equity injections.

1. ‘On balance-sheet’ to ‘Off balance-sheet’: Financing the Food Corporation of India from National Small Saving Funds at above-market rates
2. ‘Before fiscal year-end’ to ‘Right after’: Cash accounting rather than accrual accounting of subsidy and capital expenditures
3. Borrowing of one public sector enterprise (ONGC) to ‘dividend’ payout for Government of India (GoI) via the acquisition of another public sector enterprise (HPCL)

 Issues with the fiscal landscape

• Theoretical failure of fiscal deficit targeting: India’s fiscal deficit control through the Fiscal Responsibility and Budget Management Act (FRBM) has become a use case for Goodhart’s Law:

• The law says that when an economic measure is used for measurement and control but can be manipulated, then it ceases to function as a useful measure because people start to game it.

• Underestimated fiscal deficit: the error in the stated fiscal deficit is possibly larger than the Centre’s target fiscal deficit.

• A large share of taxes to be paid in the future by India’s children and youth has already been borrowed against, squeezing out fiscal space for relief efforts amidst the pandemic.

Two institutional fiscal reforms are urgently required:

• Setting up of bipartisan fiscal council: to hold a mirror to GoI’s annual progress on FRBM targets and reflect it with authenticity to citizens, similar to - 

• For, E.g. the Congressional Budget Office in the US, since 1974, has provided credible forecasts of the economic effects of both Democratic and Republican Parties’ legislative proposals.

• Independent Council: as opposed to the one recommended by the 13th Finance Commission, where the appointment and reporting were taken under Finance Ministry. 

• A bipartisan council would have a greater chance of remaining independent when it matters and not fall prey to Goodhart’s Law.

• 14th Finance Commission recommended an amendment of the FRBM Act enabling Parliament to appoint a fiscal council to undertake an assessment of the fiscal policy implications of budget proposals and their consistency with fiscal policy and rules’.

• Need for improved disclosure standard for national balance sheet: in the form of an accurately calculated Public Sector Borrowing Requirement (PSBR). 

• This will monitor total dissavings: by the Centre, the states and their respective owned enterprises.

• When PSBR exceeds net household savings (as in the past few years), private sector borrowing gets crowded out.

• Comptroller and Auditor General (CAG) seems the best positioned to provide an all- aggregate statistic on an annual basis.

• PSBR can be augmented to take account of contingent liabilities of the government resulting from explicit and implicit guarantees for targeted lending, banks and financial institutions.
  
  

Conclusion: To create additional space, medium-term commitment must be provided to reduce the overhang of government borrowings on future growth.

Quote: ‘Self-regulation is to regulation as self-importance is to importance,’ - by economist Willem Buiter.