Greek lessons for Indian economy
What lessons can the Greek market downfall teach us?
What exactly is the problem in Greece? Years of unrestrained spending, cheap lending and failure to implement financial reforms left Greece badly exposed when the global economic downturn struck. This whisked away a curtain of partly fiddled statistics to reveal debt levels and deficits that exceeded limits set by the euro zone. National debt, put at €300 billion ($413.6 billion), is bigger than the country’s economy, with some estimates predicting it will reach 120 percent of gross domestic product in 2010. The country’s deficit, how much more it spends than it takes in, is 12.7 percent. Greece’s credit rating, the assessment of its ability to repay its debts, has been downgraded to the lowest in the euro zone, meaning it will likely be viewed as a financial black hole by foreign investors. This leaves the country struggling to pay its bills as interest rates on existing debts rise. The Greek government headed by Prime Minister George Papandreou, which inherited much of the financial burden when it took office late last year, has already scrapped most of its pre-election promises and must implement harsh and unpopular spending cuts.
Greece is already in major breach of euro zone rules on deficit management and with the financial markets sure that the country will default on its debts, this reflects badly on the credibility of the Euro. There are also fears that financial doubts will infect other nations at the low end of Europe’s economic scale, with Portugal and the Republic of Ireland coming under scrutiny. If Europe needs to resort to rescue packages involving bodies such as the International Monetary Fund, this would further damage the Euro’s reputation and could lead to a substantial fall against other key currencies.
Now, the Greek government has started slashing away at spending and has implemented austerity measures aimed at reducing the deficit by more than €10 billion ($13.7 billion). It has hiked taxes on fuel, tobacco and alcohol, raised the retirement age by two years, imposed public sector pay cuts and applied tough new tax evasion regulations.
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 sizeable 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 of Concern:
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 are dismantling of administrative price mechanism in petroleum products, procurement price policy for food grains, 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 of 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 noted 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