3.1 Fiscal stability
Putting the Indian State on a sound footing in terms of public finance requires three
attributes:
1. Correct measurement of deficits and debt;
2. A declining debt/GDP ratio in all years, except for a rare calamity;7
3. Voluntary purchase of government bonds by well motivated actors.
As an example of sound public finance, Figure 5 shows the 300 year history of the
debt/GNP ratio in the UK.8 From the late 18th century onwards, the debt/GNP ratio
generally declined in normal years, with increases being mostly linked to war expenses.
Figure 4 has shown a considerable improvement in fiscal outcomes in India in recent
years. However, a careful evaluation of the sources of improvement in recent years, and
looking forward at possible scenarios, suggests that the task of placing the Indian State on
a sound footing in terms of public finance is only half complete. While remarkable progress
has come about, five key areas of concern remain:
• Accounting for off-balance-sheet liabilities Public debt should be reckoned inclusive
of the off-balance sheet liabilities such as those present owing to oil, fertiliser and the
Food Corporation of India.9 In addition, there are the unfunded promises of paying
pension to civil servants that have been estimated at over 65% of GDP (Bhardwaj
and Dave, 2006).10 Implicit guarantees that have been given to public sector finan-
cial firms are also highly valuable (Shah and Thomas, 2000). It is not possible to
evaluate whether the Debt/GDP ratio is dropping every year, and to discuss fiscal
stability associated with a given level of the deficit, if these numbers are not measured
correctly.
The FRBM Act has perhaps given government an incentive to push more debt into
such off-balance items. In 2006-07, this off balance sheet borrowing on account of
oil companies and the Food Corporation of India amounted to Rs.35,350 crore or
7 In the development economics literature, there is an argument that there is a case for running large
fiscal deficits in a developing country in order to build physical infrastructure, which would then generate
GDP growth which would then drive down the debt/GDP ratio with a lag. In India, the bulk of the
investment in areas such as roads, ports, telecom, electricity generation, etc. is increasingly structured as
public private partnerships, where private infrastructure vendors put together financing from the public
securities markets. The quantum of on-budget infrastructure expenditure is small, and its effectiveness is
limited.
8This is drawn from Janssen et al. (1999).
9An editorial in Business Standard on 19 October reports that in 2007-08, ‘oil bonds’ of Rs.23,458 crore
would be issued, and public sector oil companies would ‘absorb’ a loss of Rs.54,935 crore, owing to the
involvement of government in the market for petroleum products.
10The New Pension System involves converting the unfunded pension debt for most civil servants re-
cruited from roughly January 2004 onwards into a stream of explicit on-budget payments (Shah, 2006).
14