7th CPC Report: General Economic Situation and Financial Resources of the Central Government
Section-I
2.1.1 This Commission is required by its Terms of Reference to make its recommendations
keeping in view, inter alia:
macroeconomic performance is expected to impact the fortunes of the economy, principally through a sustained higher rate of growth of GDP.
2.1.3 In this context the two implications of the positive future growth and macroeconomic scenario that are of direct interest to this Commission are:
2.1.4 The government has two instruments to secure resources for the expenditures that they
must undertake:
Source: Budget at a glance, Union Budget of Government of India 2014-15 and 2015-16.
# Rolling Targets presented in Medium Term Fiscal Policy Statement 2015-16.
BE=Budget Estimates, RE=Revised Estimates.
2.1.6 Table 1 expresses these key fiscal aggregates as a percentage of GDP. We can see from this table that the GoI intends to reduce its overall borrowing for both revenue and capital expenditure from 4.1 percent in 2014-15 to 3 percent in 2017-18. Almost the entire reduction in fiscal deficit is to be secured by a corresponding reduction in the revenue deficit. This reduction is sought to be attained largely through containing the growth of revenue expenditure, expressed as a percentage of GDP. Thus, in the current (2015-16) budget, revenue expenditure expressed as a percentage of GDP is expected to fall by 0.9 percent. Such a drop will need to be maintained (if not increased) if the government’s medium term revenue and fiscal expenditure targets as expressed in the medium term fiscal policy statement of the Union
Budget 2015-16 (Table 1) are to be met. The impact of not meeting or revising these targets will be negative for India’s economic growth and it is for this reason that the government has repeatedly stressed its commitment to medium term fiscal prudence with the medium term targets as the basis and backed by the Fiscal Responsibility and Budget Management (FRBM) Legislation.
2.1.7 The macroeconomic aspiration to deliver double digit growth in the medium term is underpinned by a concrete commitment to immediately secure real GDP growth of at least 7.5 percent. In addition the government and the Reserve Bank of India are committed to bringing down inflation to 6 percent by January 2016 and to a formal long term target of 4 percent.
The implications of the above are:
2.1.8 The size of the government sector in the total economy, expressed as a proportion of GDP, will stay roughly constant over the medium term. This is because the increase in the size of government (expressed as a percentage of GDP) can only be financed through an increase in the revenue-GDP ratio and/or an increase in the FD-GDP ratio. The latter ought not to happen; indeed the government is committed to reducing the FD-GDP ratio over the medium term as discussed above. If the Revenue-GDP ratio is increased then:
2.1.9 At the same time the government has emphatically indicated key government spending priorities that will involve substantial financing of both current and capital expenditures over the medium term to fulfil government’s core obligation to provide public as we as merit goods and services. Hence, equally it cannot be assumed that there will be a reduction in the size of the government.
2.1.10 Since PAP is entirely revenue expenditure and since revenue-GDP ratio increases will first be deployed to reduce the revenue deficit, it follows that there is no fiscal space available to increase the share of the total spending on PAP other than that afforded by GDP growth. The share of PAP in total revenue expenditure will, at best, stay constant over the medium term.
2.1.11 It therefore follows that any increase in PAP that can be financed without jeopardising the government’s macro fiscal parameters can, in the medium term, at most be equal to the growth rate of GDP. Of course, due to the peripatetic, decennial, occurrence of the Pay Commission recommendations this condition cannot be met in the initial year of award, as the award has to adjust for many cumulative factors that have negatively impacted the purchasing power of the PAP over the historical medium term. Even so it is important to ensure that the increase in the PAP-GDP ratio in the initial year of the award is moderate, so that it stabilizes over the medium term (provided growth is secured as planned).
Section-I
2.1.1 This Commission is required by its Terms of Reference to make its recommendations
keeping in view, inter alia:
i. the economic conditions in the country and the need for fiscal prudence;2.1.2 The Government of India (GoI), Economic Survey 2014-15 is optimistic and bullish about the future: “a political mandate for reform and a benign external environment have created a historic moment of opportunity to propel India onto a double-digit growth trajectory. Decisive shifts in policies controlled by the Centre combined with a persistent, encompassing, and creative incrementalism in other areas could cumulate to Big Bang reforms....” The survey also clarifies that “…macroeconomic fundamentals have dramatically improved for the better, reflected in both temporal and cross-country comparisons....” This improvement in
ii. the need to ensure that adequate resources are available for development expenditures and welfare measures;
iii. the likely impact of the recommendations on the finances of the State Governments, which usually adopt the recommendations with some modifications.
macroeconomic performance is expected to impact the fortunes of the economy, principally through a sustained higher rate of growth of GDP.
2.1.3 In this context the two implications of the positive future growth and macroeconomic scenario that are of direct interest to this Commission are:
1. The incremental fiscal space that will be secured through such improved macro
performance.
2. The constraints imposed by the macro fiscal framework that government will adopt through to 2017-18 which will be underpinned by its FRBM legislation.
2.1.4 The government has two instruments to secure resources for the expenditures that they
must undertake:
a. Revenue Mobilisation2.1.5 Government spending (like for all other economic agents) can be divided into consumption (revenue) and investment spending. The fiscal deficit1 (FD) conceptually measures the difference between total government spending and total non debt receipts thereby indicating the total amount the government needs to borrow to finance its projected expenditure. The revenue deficit (RD) measures the difference between government’s total revenues and its consumption (revenue) expenditure. The core focus of this Commission is on Pay, Allowances and Pensions (PAP), which is fully revenue expenditure.
b. Borrowing
Table 1: Macro Fiscal Position of the Centre
# Rolling Targets presented in Medium Term Fiscal Policy Statement 2015-16.
BE=Budget Estimates, RE=Revised Estimates.
2.1.6 Table 1 expresses these key fiscal aggregates as a percentage of GDP. We can see from this table that the GoI intends to reduce its overall borrowing for both revenue and capital expenditure from 4.1 percent in 2014-15 to 3 percent in 2017-18. Almost the entire reduction in fiscal deficit is to be secured by a corresponding reduction in the revenue deficit. This reduction is sought to be attained largely through containing the growth of revenue expenditure, expressed as a percentage of GDP. Thus, in the current (2015-16) budget, revenue expenditure expressed as a percentage of GDP is expected to fall by 0.9 percent. Such a drop will need to be maintained (if not increased) if the government’s medium term revenue and fiscal expenditure targets as expressed in the medium term fiscal policy statement of the Union
Budget 2015-16 (Table 1) are to be met. The impact of not meeting or revising these targets will be negative for India’s economic growth and it is for this reason that the government has repeatedly stressed its commitment to medium term fiscal prudence with the medium term targets as the basis and backed by the Fiscal Responsibility and Budget Management (FRBM) Legislation.
2.1.7 The macroeconomic aspiration to deliver double digit growth in the medium term is underpinned by a concrete commitment to immediately secure real GDP growth of at least 7.5 percent. In addition the government and the Reserve Bank of India are committed to bringing down inflation to 6 percent by January 2016 and to a formal long term target of 4 percent.
The implications of the above are:
2.1.8 The size of the government sector in the total economy, expressed as a proportion of GDP, will stay roughly constant over the medium term. This is because the increase in the size of government (expressed as a percentage of GDP) can only be financed through an increase in the revenue-GDP ratio and/or an increase in the FD-GDP ratio. The latter ought not to happen; indeed the government is committed to reducing the FD-GDP ratio over the medium term as discussed above. If the Revenue-GDP ratio is increased then:
a. The additional resources will be used to reduce the RD.
b. Following the recommendations of the Fourteenth Finance Commission (FFC) the Centre will get a lower share in the divisible pool of taxes than in the past i.e., 58 percent in 2015-16 to 2019-20 as compared to 68 percent in the period 2010-11 to 2014-15. This further limits the possibility of a significant increase in net revenue receipts of the Centre.
2.1.9 At the same time the government has emphatically indicated key government spending priorities that will involve substantial financing of both current and capital expenditures over the medium term to fulfil government’s core obligation to provide public as we as merit goods and services. Hence, equally it cannot be assumed that there will be a reduction in the size of the government.
2.1.10 Since PAP is entirely revenue expenditure and since revenue-GDP ratio increases will first be deployed to reduce the revenue deficit, it follows that there is no fiscal space available to increase the share of the total spending on PAP other than that afforded by GDP growth. The share of PAP in total revenue expenditure will, at best, stay constant over the medium term.
2.1.11 It therefore follows that any increase in PAP that can be financed without jeopardising the government’s macro fiscal parameters can, in the medium term, at most be equal to the growth rate of GDP. Of course, due to the peripatetic, decennial, occurrence of the Pay Commission recommendations this condition cannot be met in the initial year of award, as the award has to adjust for many cumulative factors that have negatively impacted the purchasing power of the PAP over the historical medium term. Even so it is important to ensure that the increase in the PAP-GDP ratio in the initial year of the award is moderate, so that it stabilizes over the medium term (provided growth is secured as planned).
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