Willem H. Buiter and Urjit R. Patel have written this paper titled Fiscal Rules in India: Are They Effective? I could not find a free version of the paper so it is available only to NBER subscribers.
The summary of the paper is also given here at Brookings website:
The “outcomes” section of the paper clearly shows that the central government has missed both the fiscal and revenue deficit targets by some margin. Its fiscal deficit for the terminal year, 2008/09, was 6 percent of GDP, excluding estimated off-budget expenditure (settled by IOUs or simply ignored) of about 2 percent of GDP. After 2004/05, not only has there been no fiscal correction once off-budget items are included, but indicators mostly deteriorated. Taking into account off-budget expenditure, it is amply clear that the FRBMA “transition” annual targets towards a 3 percent of GDP fiscal deficit and balance on the revenue account by 2008/09 were exceeded before the onset of the 2008 Great Recession. Moreover, the FRBMA’s clauses were insufficient to prevent the finance minister from excluding (unpaid) dues on account of subsidies in calculating the fiscal and revenue deficits; the provision for off-budget bonds was inadequate to cover the expenditure overrun (or deliberately shown to be low); for example, estimates by market analysts suggest that excess expenditure was about 1.9 percent of GDP in 2007/08.
The adverse evolution in the center’s fiscal balances was not on account of the operation of automatic stabilizers during a cyclical slowdown; on the contrary, the Indian government’s revenues have been buoyant. The gross tax-GDP ratio increased from 9.7 percent in 2004/05 to 12.6 percent in 2007/08 on the back of an almost 9 percent average annual real growth rate. The recent profligacy of the central government has its primary driver in populist spending policies by the ruling coalition leading up to national elections in May 2009. Three stimulus packages, including a reduction in indirect taxes, starting in late 2008 to counter global recessionary headwinds only helped matters along in the same direction. Much of the slippage on the expenditure side can be attributed to large and increasing energy, food and fertilizer subsidies; funding loss-making public sector units; expanding a rural income support scheme (started in 2005); increasing salaries and pensions of civil servants (implemented in 2008), and a huge agricultural loan waiver scheme announced in early 2008 but not budgeted for!
Then State governments finances have improved which has been usurped by Centre:
Fiscal consolidation by state governments (in aggregate) in recent years has been commendable. Between 2003/04 and 2007/08, their fiscal deficit declined markedly from 4.4 percent to 1.5 percent of GDP. The main explanation being that enhanced budget revenues were not offset by discretionary action on the expenditure side. During 2008/09, the fiscal performance deteriorated somewhat with the deficit at 2.6 percent of GDP, but still below the mandated 3 percent ceiling. This was due to the economic slowdown and the accompanying moderation in the pace of revenue growth. However, the revenue deficit in most states was within the target of zero balance in 2008/09. The management of states of their fiscal affairs over both a period of high growth and the subsequent slowdown exhibits successful conduct of “discretionary countercyclical” policy within the rules. Therefore, the recent deterioration in India’s national fiscal situation cannot be blamed on state governments. The evidence suggests that in recent years the fiscal space “vacated” by the states has been usurped by the central government. Nevertheless, caution is warranted: recent fiscal restraint by state governments does not necessarily imply continuation of rectitude in the future.
What are the options ahead?
Political opportunism (rational at the individual, partisan level) in India as elsewhere calls for the postponement of expenditure cuts or tax increases and the prompt spending of revenue windfalls. There is always the chance that the political cost of painful fiscal retrenchment will be borne by the opposition, when its turn in office comes around. The main difficulty thrown up by our analysis of outcomes under the FRBMA and other FRLs remains the design of a fiscal rule to incentivize the government not to give in to a procyclical bias, which behaviourally and in practice is especially pertinent for policy during upswings.
It is not surprising that given the fiscal situation in India, there has been a flurry of activity. Both the 13th Finance Commission’s report and the central government’s 2010/11 budget have laid out a road map to cut the fiscal deficit and public debt over the next five years. Drawing lessons from the central government’s conduct in recent years, the FC’s report has, to its credit, made constructive suggestions for changes in the areas of transparency, limited in-built flexibility, and enhancing the integrity of fiscal policy in the design of future legally-binding rules. Although the “golden rule”, a balanced revenue budget, has been maintained as an objective in the latest proposals, the important change in emphasis is the dominance of gross public debt-GDP ceilings over the next five years. It is noteworthy that the FC spurned the opportunity to demonstrate innovation in the urgent and difficult task of designing and implementing a time consistent fiscal rule for the sovereign (in a democracy which shows a sustained proclivity for running high fiscal deficits without public opprobrium). In this context, we draw the paper to a close by outlining a basic incentive compatible framework for state and central governments to hold each other accountable over agreed pre-determined targets.
A very good paper on Indian public finances..