Relevance: GS-2: Government Policies and Interventions for Development in various sectors and issues arising out of their Design and Implementation.

Key Phrases: freebies, fiscal profligacy, freebie culture, Fiscal Responsibility and Budget Management (FRBM), Financial Emergency, Comptroller and Auditor General of India (CAG), Off Budget Freebies.

Why in News?

• During election campaigns various political parties promise freebies either in cash or kind to electorate ,if they are voted to power.
• Electoral promises of this kind raise several questions regarding the sustainability of borrowing and spending on freebies and their opportunity cost.

Growing freebie culture:

• Many states are pursuing the freebie culture, some even more aggressively than Punjab.
• Ideally, governments should use borrowed money to invest in physical and social infrastructure that will generate higher growth, and thereby higher revenues in the future so that the debt pays for itself.
• On the other hand, if governments spend the loan money on populist giveaways that generate no additional revenue, the growing debt burden will eventually implode and end in tears.
• Concerned by an increasing number of states that are embarking on this financially ruinous path, senior bureaucrats reportedly flagged the issue that ‘some States might go down the Sri Lankan way’.

Off Budget Freebies:

• By looking at any analysis of State Budgets by the Reserve Bank of India or any think tank, the inference is drawn that State finances are in good, if indeed robust, health and that all of them are scrupulously conforming to the Fiscal Responsibility and Budget Management (FRBM) targets.
• But this is a misleading picture as much of the borrowing that funds these freebies happens off-budget, beyond the pale of FRBM tracking.
• The typical modus operandi for States has been to borrow on the books of their public enterprises, in some cases by pledging future revenues of the State as a guarantee.
• Effectively, the burden of debt is on the State exchequer, albeit well concealed.
• The Comptroller and Auditor General of India (CAG) pointed out that in respect of some States ‘if extra-budgetary borrowings are taken into account, the government's liabilities are way above what is acknowledged in the official books.’

How big is the problem?

• There is no comprehensive information in the public domain to assess the size of this off-budget debt, but anecdotal evidence suggests that it is comparable in size to the debt admitted in the Budget books.
• The obvious motivation for States in expanding freebies is to use the exchequer to build vote banks.
• A certain amount of spending on transfer payments to provide safety nets to the most vulnerable segments of the population is not only desirable but even necessary.
• The problem arises when such transfer payments become the main plank of discretionary expenditure, the spending is financed by debt, and the debt is concealed to circumvent the FRBM targets.
• The more States spend on transfer payments, the less they have for spending on physical infrastructure such as, for example, power and roads, and on social infrastructure such as education and health, which can potentially improve growth and generate jobs.
• The truth of the Chinese saying, ‘give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime’ is self-evident to everyone, including politicians.
• But electoral calculations tempt them to place short-term gains ahead of long-term sustainability.

The cost of freebies:

• The costs of fiscal profligacy at the State level can be huge.
• The amount States borrow collectively every year is comparable in size to the Centre’s borrowing which implies that their fiscal stance has as much impact on our macroeconomic stability as does that of the Centre.

Institutional checks and balances

• All the institutional checks and balances seem to become ineffective.
• Opposition:
  • In theory, the first line of defence has to be the legislature, in particular the Opposition, whose responsibility it is to keep the Government in line.
  • But given the perils of our vigorous democracy, the Opposition does not dare speak up for fear of forfeiting vote banks that are at the end of these freebies.
• CAG Audit:
  • It should enforce transparency and accountability.
  • In practice, it has lost its teeth since audit reports necessarily come with a lag, by when political interest has typically shifted to other hot button issues.
  • Besides, our bureaucracy has mastered the fine art of turning audit paras into ‘files’ which run their course and die a quiet death.
• Market:
  • It can signal the health or otherwise of State finances by pricing the loans floated by different State governments differently, reflecting their debt sustainability.
  • But in practice this too fails since the market perceives all State borrowing as implicitly guaranteed by the Centre, never mind that there is no such guarantee in reality.

Suggestions:

• Amendment in FRBM:
  • The FRBM Acts of the Centre as well as States need to be amended to enforce a more complete disclosure of the liabilities on their exchequers.
  • Even under the current FRBM provisions, governments are mandated to disclose their contingent liabilities, but that disclosure is restricted to liabilities for which they have extended an explicit guarantee.
  • The provision should be expanded to cover all liabilities whose servicing obligation falls on the Budget or could potentially fall on the Budget, regardless of any guarantee.
• Conditionalities of borrowing:
  • Under the Constitution, States are required to take the Centre’s permission when they borrow.
  • The Centre should not hesitate to impose conditionalities on wayward States when it accords such permission.
  • States slapped with conditionalities will of course balk and allege political motives.
  • The challenge for the Centre will be to act transparently and by well-defined, objective, and contestable criteria.
• Financial Emergency:
  • There provision in the Constitution of India which allows the President to declare a financial emergency in any State if s/he is satisfied that financial stability is threatened.
  • This has never been invoked so far for fear that this will turn into a political weapon of mass destruction.
  • But the provision is there in the Constitution for a reason. After all, the root cause of fiscal irresponsibility is the lure of electoral nirvana. It will stop only if the political leadership fears punishment.
  • It is therefore important to ensure that the prospect of a financial emergency in case of gross and continuing fiscal irresponsibility is not just an abstract threat but a realistic one.

Conclusion:

• The Centre itself has not been a beacon of virtue when it comes to fiscal responsibility and transparency.
• It should complete that task to command the moral authority to enforce good fiscal behaviour on the part of States.
• There is a need for instituting more effective checks that can make wayward States fall in line is compelling.

Source: The Hindu

Mains Question:

Q. What are the causes of the growing freebies culture during state elections? Give some suggestions to curb this fiscal profligacy.