World Bank on India’s Fiscal Policy


In the early days after Independence, India was not only conscious of but asserted its sovereignty in policy making in every sphere of life, be it economic, social, political and defence. It listened to all but took its own decisions keeping in view its own interests. The goals championed by the national movement remained supreme and sacrosanct. One may recall numerous examples to bring home this point. Those days are long past. Now, it seems foreign experts and supranational agencies are calling the tune. They have an advantage in having persons loyal to them occupying key positions in various echelons of the decision-making apparatus of the government.

To bring home this point, let us refer to a very recent report from the World Bank. It is entitled State Fiscal Reforms in India: Progress and prospects, released in India on 23 November at Kolkata, Mumbai, Patna, Chennai, Hyderabad, Chandigarh, Bangalore, Lucknow, Bhubaneshwar and in Jharkhand besides New Delhi.

The officials of the World Bank did their best to impress on the officers of Central as well as State governments the urgent need of accepting the report and implementing its recommendations. Even a cursory glance is enough to convince that implementation has already begun and the coming Central and State budgets will incorporate the recommendations in their fiscal proposals. The report has been co-authored by Stephen Howes, V.J. Ravishankar and Marina Wes.

It is interesting to note that the World Bank began its regular intrusion in India’s fiscal affairs in 1996 when a non-Congress government was in power at the Centre and P. Chidambaram was its finance minister and Montek Singh Ahluwalia was an influential officer in his ministry. The World Bank prepared its first report on Orissa in 1996. Since then it has come out with more than a dozen in-depth reports on almost all major States. Obviously, it was provided with all kinds of confidential and not-so-confidential data by government agencies.

The report claims at the very outset that it has no other motive except seeing India and its States come out of the existing financial mess and adopt fiscal policies focused on accelerating its economic growth.

It has covered 16 large States, accounting for 93 per cent of India’s population and within them special focus has been on seven poorest ones where average annual per capita income is less than Rs 10,000. These are Bihar, Chhattishgarh, Jharkhand, Madhya Pradesh, Orissa, and U.P. It needs to be noted here that the average per capita income in them as percentage of the all-India average has fallen from 71 per cent in 1980-81 to 54 per cent in 1999-2000. It is obvious that regional disparities have increased since the onset of economic reforms to integrate India with the global economy. The poorer States have been increasingly lagging behind their richer counterparts in the matter of economic growth.

This phenomenon has been reflected in gradual deterioration in fiscal performance of the States, especially the poorer ones. According to the Bank, the acceptance of the recommendations of the Fifth Central Pay Commission aggravated the situation. A sharp increase in expenditures when the revenue receipts were falling resulted in much higher deficits and debt burden. The poor States were more hard hit as was shown by the ratio of the State level debt and GSDP (Gross State Domestic Product), which was 45 per cent in 2003-04 as against 20-25 per cent in other States. This had serious implications for economic growth in poor States. They were hard put to find resources for developmental as well as welfare spending after meeting growing burdens of interest and pension payments and increased salary bills. The Bank holds that the quality of spending worsened, as expenditures became more salary-intensive, especially in the poorer States.

In recent years some efforts have been made to improve the fiscal position in States like Haryana and Karnataka by restraining salary and wage bills and reducing interest rates. Most other States, however, have remained saddled with large revenue and fiscal deficits. They continue to face increasing debt burdens. The Bank has described Indian States as the most highly indebted in the world. Besides, poor States are showing almost no signs of recovery. In the opinion of the World Bank though they show signs of “reform fatigue”, there is no way out but to accelerate the process of reforms. Without further and comprehensive reforms the situation will only worsen.

While stressing the need for spending not only more but also effectively on priority areas, budgetary deficit must be reduced. For this the Bank has stressed the need of restructuring expenditures and reforming tax policy and administration. Both the Centre and the States have to initiate immediate steps in this direction.

At present salary payments account for 30 per cent of spending. This situation is not desirable and the Central as well as State governments must initiate immediate steps to restrain salary and wage bills so that in the next ten years at least 2 per cent of GDP is saved. The World Bank maintains that most public sector employees are overpaid as compared to their private sector counterparts.

Another across the board pay increase will worsen the situation irretrievably.

The Central government has to take the lead by adopting a tough stand and categorically stating: no more pay commissions and no across the board hikes in salaries and wages of its employees. It will be then easier for State governments to tackle the pressures from their employees. Since VRS (Voluntary Retiring Schemes) have failed to reduce the number of employees, governments have been asked to adopt other measures to reduce their size. In other words, the ban on government recruitment must continue. The World Bank has cited the case of primary school teachers in various parts of the country to show that their emoluments more than tripled between 1995 and 2003. Obviously, it thinks it was unwarranted.

So far as the pensions are concerned, it supports the reform introduced by the NDA government and being continued by the UPA government that the employees themselves provide for their pensions. On the question of subsidies, the Bank does not know how to tackle it. It accepts that success on this front is much more difficult. Yet, it maintains that instilling commercial discipline into subsidised sectors is a sine qua non. In some areas, privatisation is the only answer.

Public enterprise reforms must be undertaken so that the need for budgetary support to loss-making units is eliminated so that liabilities do not pile up in the future.

To increase revenue, tax base has to be broadened and tax administration simplified so that corruption is reduced if not wholly eliminated. The Bank has underlined the urgency of VAT by removing all the impediments in its way. The scope of taxation of services needs to be widened and it should be integrated with the VAT and transferred to States. In the course of time a unified Centre-State VAT needs to be evolved.

The World Bank is in favour of levying professional tax. It views it as an income tax supplement: potentially important, but currently neglected. With an increase in the constitutional ceiling and better administration, its yield could increase from 0.1 per cent to 0.9 per cent of GDP.

The Bank holds that cars and two-wheelers are, at present under taxed, compared to heavy vehicles like buses. Hence the incidence of taxation on them can be safely increased.

The non-tax revenues have stagnated over the years, now sufficient attention must be given to them to get higher yield from them.

So far as tax administration is concerned, the Bank wants the Finance Commission to be made a permanent body like the Planning Commission. Besides, it wants more honesty and greater transparency in tax administrations. The element of discretion and the official-tax payer interaction have to be reduced substantially. The scope of self-assessment and computerization has to be widened. Tax evasion has to be dealt with as harshly as possible.

It is surprising that there is no debate in the country on these recommendations. It is surprising that the Bank has tried to sweep under the carpet the distributive and allocative roles of fiscal policy and ignored the mandate inherited from the national movement that socio-economic inequalities and regional disparities must be reduced if not totally eliminated. The fiscal policy has utterly failed to do this. The result is what Time magazine has recently described the emergence of two Indias in its story entitled “Tale of Two Indias”.

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