The Pay Commission will be the biggest challenge
Rationalising of government expenditure on subsidies, currently around 2.7% of the GDP if you factor in that part of the oil under-recoveries that are not accounted for in the Budget, contrary to what it seems right now, is probably going to be the newly-constituted Expenditure Management Commission’s (EMC) easiest job. Just reducing the diesel subsidy to near-zero over the next few months, for instance, will lower the annual subsidy bill by R63,000 crore, the amount this was in FY14—that's 0.6% of GDP. Were the government to move to cash subsidies for the Food Security Act, this will save another 0.3-0.4% of GDP—on the assumption that, instead of the expensive Food Corporation of India (FCI) procurement and distribution, each family is given a cash subsidy of around R15 per kg of wheat and rice, roughly the difference between the free market and the ration shop price. Since indications are the government is now firmly backing the Aadhaar-based direct benefits transfer—indeed this is an integral part of the financial inclusion plan the prime minister will announce later today—it is safe to assume these savings amounting to around 1% of GDP will take place; there could be more once a similar exercise is done for fertiliser and other subsidies.
Which is why, if you go back to finance minister Arun Jaitley’s budget speech, after talking about the EMC, he says “I also propose to overhaul the subsidy regime ...”. The EMC’s primary task will be to deal with the impact of the 14th Finance Commission (FC) as well as the 7th Pay Commission (PC). While it is not clear if the FC will give states 50% of central taxes as automatic devolution—this is what the BJP states, primarily, have asked for—each Commission hikes the percentage devolved. Since any extra devolution will be matched by a corresponding reduction in central assistance for State plans, the EMC’s main task will be to see how certain types of expenditures by various ministries are to be re-organised, to examine how their efficacy can be raised—are education vouchers a better substitute for expensive but poor quality government schools?
The EMC’s bigger challenge will be to deal with the impact of the 7th Pay Commission and the need for compensation for states moving to the GST. As a proportion of GDP, central government salaries—and this does not take into account, for instance, teachers whose salaries are paid for by the government but who do not figure in the 36 lakh government employees in the Budget—rose from 0.9% in FY08 to a likely 1.1% in FY15. If a larger hike is expected in FY16 to take into account soaring inflation levels—the PC is to be implemented from January 2016 according to the plan—that’s another 0.3-0.4% of GDP that needs to be built in immediately; by the time the impact on salaries of teachers and others is taken into account, the number gets a lot higher, more so since states will also press the Centre to defray a part of their higher wage bills resulting from the PC. If the government plans to spend more on building infrastructure—to fund new cities, part of the diamond quadrilateral, etc—the task of expenditure compression is going to be that much tougher.