States, freebies and the costs of fiscal profligacy

CategoryPolity

Last Updated29/06/2022

Need for instituting more effective checks that can make wayward States fall in line is compelling.

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Political parties are outdoing each other in promising free electricity and water supply, laptops, cycles, electronic appliances, etc.
These are called ‘freebies’ and are characterized as fiscally imprudent.
Governments should use borrowed money to invest in physical and social infrastructure.
It will generate higher growth, and thereby higher revenues in the future so that the debt pays for itself.
If governments spend loan money on populist giveaways, the growing debt burden will eventually increase.

Analysis of State Budgets by RBI or any think tank,shows that State finances are in good health, and conforming to FRBM.
It is misleading.
Borrowing that funds freebies happens off budget, beyond FRBM tracking.
Burden of debt is on State exchequer, although concealed.
CAG: if extra-budgetary borrowings are taken into account, liabilities of government are way above what is acknowledged in the official books’.

Motivation for States in expanding freebies is to build vote banks.
Problem arises when transfer payments become discretionary expenditure, spending is financed by debt, and debt is concealed to circumvent FRBM targets.

All of them have become ineffective.
Opposition: whose responsibility it is to keep the Government in line.
But they don’t speak for vote banks that are at end of these freebies.
CAG audit : which should enforce transparency and accountability.
Lost its teeth since audit reports necessarily come with a lag.
Market is another potential check.
It can signal health of State finances by pricing loans floated by different State governments differently, reflecting their debt sustainability.
But market perceives all State borrowing as implicitly guaranteed by Centre.

FRBM Act: Acts of Centre as well as States need to be amended.
Aim: to enforce more complete disclosure of liabilities on their exchequers.
Permission denied: Under the Constitution, States require Centre’s permission when they borrow.
Centre should not hesitate to impose conditionalities.
Financial emergency: President can declare financial emergency in any State if s/he is satisfied that financial stability is threatened.
It has never been invoked as this will turn into a political weapon of mass destruction.
Punishment: Root cause of fiscal irresponsibility is the lure of electoral success.
It will stop only if political leadership fears punishment.