Table 3 also shows that the revenue decline continued and interest payments rose further during the Ninth Plan period, “compensated” by additional cuts in capital expenditure. Falling revenues account for 0.9 of the 1.4 percentage points of GDP rise in primary deficit relative to the Eighth Plan period. As capital expenditure endured a further cut of 0.4 percentage points, it follows that the rise in non-interest current spending in the form of higher salaries, pensions and administrative costs accounted for about 1 percentage point of GDP. This was probably driven by the Central Fifth Pay Commission award, the implementation of which began in 1997 at the center, followed the next year by the states.

Summarizing, we can say that relative to the pre-crisis mid 1980s, tax and financialrepression revenues fell by 2.5 percentage points of GDP during the 1990s as a result of needed reforms, offset by a compression in capital expenditure;<sup>18</sup> while the Fifth Pay Commission award probably had a negative impact of about 1 percentage point of GDP. The impact of the latter is expected to attenuate over time, because of the discrete nature of civil service wage increases. Moreover, the issue is not so much that the civil service is over-staffed or the wage bill excessive when scaled by population and GDP respectively, but more that there is a skills imbalance, with most of the employment concentrated in low-skill jobs, which pay considerably more than comparable jobs in the private sector; with fewer and probably under-paid staff at the higher skills level needed for efficient social service delivery.<sup>19</sup> Hence, reversing the fiscal slide needs to focus on mobilizing revenue and restoring government capital and development expenditure; cutting the wage bill is a secondary issue.

# 2.3 _Government Debt Dynamics_

The change over time in the general government debt-to-GDP ratio can be decomposed into two parts: the first attributable to the primary deficit/GDP ratio (pd); and the second, a term proportional to the difference between the real interest rate paid on government debt and the growth rate of real GDP, (r-g). During financial repression, we would expect the rise in debt to be less than the primary deficit (as ratios of GDP), because interest rates are kept artificially low; but with financial liberalization, interest rates would tend to rise and might eventually exceed growth rates, putting government debt on a much faster upward trajectory. We shall show that this is what happened during the Ninth Plan period.

Figure 2 presents the primary deficit and the term proportional to (r-g) based on the standard difference equation for government debt shown in Annex 2. It can be seen that after 1994/95, the term proportional to (r-g) becomes smaller in magnitude and over the last four years, has been either positive or close to zero, no longer offering the offset to the primary deficit that it did when financial repression was the norm.

> 18 While revenues fell and interest payments rose further during the Ninth Plan period, it is impossible to say what part of this is cyclical and what part due to reforms, so the 2.5 percentage points should be treated as a lower bound. 19 World Bank (2003) contains an analysis of the wage bill issue and the need for civil service reform.

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