LIMITING GOVERNMENT EXPENDITURE

Elected governments are composed of different interest groups and lobbies. At times, such governments might intend to use its economic policies in a highly populist way for greater political mileage without caring for the national exchequer. Such acts might force the governments to go in for excessive internal and external borrowing and printing of currency. Governments generally avoid to increase tax or impose new taxes for their revenue increase as such acts are politically unpopular. On the other hand, borrowings and printing of currency impose no immediate economic or political costs. A government in the election year usually spends money frugally by borrowings (from the RBI in India) because it is the coming government after the elections who is supposed to repay them. Government expenditures remain higher and expanding due to some economic reasons also—by doing so extra employment is generated and the output (GDP) of the economy is also boosted. If governments go for anti-expansionary fiscal and monetary policies with the objective of reducing its expenditures the employment as well as the GDP both will be hampered. This is considered a bias in the economic policies of the elected governments. But there has always been a consensus among the experts and policymakers that an

external (i.e., outside the government) and some form of a statutory check must be over the government on its powers of money creation (i.e., by borrowings or printing). With the objective of removing the bias—to make fiscal policy less sensitive to electoral considerations, several countries had introduced some legal provisions on their governments before India enacted its FRBMA. We see mainly three variants of it around the world:

(i) It was New Zealand which first introduced such a legal binding on the government’s powers of money creation. Here the central bank is legally bound to ensure that money creation by the government does not increase the rate of inflation target—it means that the central bank has the overriding powers on the government there in the area of extra money creation.46

(ii) The second variant is putting some firm legal or constitutional limit on the size of government deficits or the power of the government to borrow. Germany and Chile had such an arrangement—today Germany is bound to the fiscal limits prescribed by the Maastricht Treaty. In the late 1990s, an upper limit on the government’s powers to create deficit was introduced.47

(iii) Some countries introduced the so-called ‘Currency Board’ type of arrangement to serve the same purpose—this is the third variant. In this arrangement, money supply in the economy is directly linked to changes in the supply of foreign assets—neither the government nor the central bank has any independent powers to create money, as growth in money supply is not allowed to exceed growth in the foreign assets.48

It was in 1994 that India took the first step in this direction when the central government had a formal agreement with the RBI to limit its borrowing through ad hoc treasury bills to a predetermined amount (Rs. 6,000 crores in 1994–95).49 However, it was a highly liberal arrangement with the government having the ultimate powers to revise the aforesaid predetermined amount by a fresh agreement with the RBI. The importance this beginning had was finally in the enactment of the FRBMA 2003—a historic achievement in the area of fiscal prudence in the country.