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Don’t lean on fiscal deficit! What the govt must do to arrest the fall

Equity infusion in the PSBs has been done in this manner. As a result, there is no impact on fiscal deficit, but the debt and liabilities increase.

By Subhash Chandra Garg

Fiscal Deficit (FD) represents net borrowings in a year. As difference between the debt and liabilities also represent net borrowings, FD should equal the change. All government expenditure, revenues and debts are required to be carried out through Consolidated Fund of India (CFI). If this is done, FD should represent additional debt incurred.

Unfortunately, all transactions are not recorded. Some debt/liabilities are recorded either in the Public Account or totally outside the system. Some liabilities-related transactions deduct a corresponding debt receipt from the expenditure, these are called below the line/off budget. Equity infusion in the PSBs has been done in this manner. As a result, there is no impact on fiscal deficit, but the debt and liabilities increase. During 2004-09, bonds were issued to oil and fertiliser companies, and were accounted for in the Public Account, to pay oil/fertiliser under-recoveries. For some years now, Centre has been issuing fully serviced bonds (FSBs), these are used from SPVs outside budget to pay off the government expenditure/subsidy. Interest & principal is serviced by GoI. The government has been paying off the food subsidy liability by providing cash from the National Small Savings Fund (NSSF).
The FD, stated in the budget papers, is exclusive of these four variations.

Actual fiscal deficit in FY18
Actual numbers are available only up to the year FY18: FD as reported in budget, in FY18 was Rs 5,91,062 crore—3.5% of the nominal GDP (Rs 170.95 lakh crore).
There is a need to add the following. Rs 80,000 crore of equity infusion was done at PSBs, in lieu of investment in the special government-issued securities. FCI was given a Rs 65,000 crore loan from NSSF for food subsidies,Rs 3,105 crore of FSBs were issued to pay for the cost of irrigation projects under the ministry of water resources. Rs 4,000 crore was raised for Deen Dayal Gram Jyoti and Saubhagya schemes. Another Rs 7,330 crore for subvention support under PM Awas Yojana,Rs 660 crore of FSBs were issued to cover similar liabilities of Inland Waterways Authority of India . In all, FSBs of Rs 15,095 crore were issued. These three expenditures made up Rs 1,60,095 crore (0.94% of GDP). Adding these to the headline FD takes the actual number to Rs 7,51,157 crore—(4.39%).

Fiscal deficit in 2018-19
Actual accounts for FY19 are still not published. However, the CGA has published provisional accounts. Headline FD is Rs 6,45,367 crore (3.4% of Rs 190.10 lakh crore GDP), in line with FY19RE. Following three expenditures should be added—equity investments in PSBs and EXIM Bank, food subsidy expenditure & FSB issuances. GoI provided Rs 1.06 lakh crore as “recapitalisation bonds”. Further, Rs 70,000 crore was provided from the NSSF. FSB issuance ballooned to Rs 64,192.10 crore. Expenditure was, thus, Rs 2,40,192 crore. Actual FD was Rs 8,85,559 crore (4.66%). Fiscal performance in FY20 has been weak. Nominal GDP growth has fallen to 7.5%. Compared with the provisional/actual tax revenues for FY19, the estimated tax revenues at Rs 16.50 lakh crore (7.82% of projected GDP FY20) are Rs 3.33 lakh crore higher . Actual tax performance has been quite poor. The decision to reduce corporate tax rates has also contributed. Personal income taxes are also growing slowly. GST revenues are not very robust, substantial shortfall exists in excise and customs duties. Non-tax revenues are doing quite well, thanks to RBI. There is also good likelihood that a part of licence fee and spectrum charges arrears linked to AGR will materialise. Dividend from PSUs, including from PSBs , especially from SBI, will be closer to the budgetary targets—an additional revenue of Rs 50,000 (+/- Rs 10,000 crore). Less than 20% target (Rs 1.05 lakh crore) in divestment has been achieved till now. Three disinvestments (BPCL, SCI and CCIL), at about Rs 80,000 crore or so, were the biggest hope for achieving the target. However, it is unlikely that sale of all the three, especially BPCL, which was set to provide about 3/4th, would be complete by FY20. GoI may miss the target by Rs 50,000 crore. Hence, a likely shortfall of Rs 2-2.5 lakh crore on revenue side.

GoI has recently directed limiting expenditure to 25% of the budgeted amount in Q4FY20. Considering the nature of government expenditure (50% is establishment and interest payments) and 65.3% has already been incurred until November 2019, government will not be able to save much . It will have to resort to the food subsidy adjustments again.

The headline number could go up by Rs 1.3-2 lakh crore (0.6-1% of GDP), FD is likely to be between 3.7-4%. Like earlier years, three heads of expenditure—recapitalisation, food subsidy and FSBs—are likely to be between `1.75-2.25 lakh crore with FD around 4.5% to 5%.

Debt and liabilities
GoI’s debt and liabilities are published in the annual Status Paper on Government Debt. The FY18 numbers were released in January 2018, FY19 numbers have not yet been released. DEA also brings out a quarterly publication—Public Debt Management—primarily dealing with GOI’s ‘market borrowings’. Q2FY20 report was released in December 2019. GoI also publishes a Statement of Liabilities. Final numbers are available for only FY18, hence, reconciliation has been carried out for FY18.

Budgetary Statement puts total debt and liabilities at Rs 82.35 lakh crore. The Status Paper reports Rs 77.99 lakh crore—a difference of Rs 4.36 lakh crore. This is primarily on account of two items—external debt and investment by NSSF into state government securities. Status Paper takes into account current value (Rs 4.83 lakh crore) of the external debt whereas budgetary statement takes external debt at historical exchange values (Rs 2.50 lakh crore)—a difference of Rs 2.33 lakh crore. The second difference is due to differential treatment of two elements of investments made from the NSSF. Status Paper excludes two items—Investment of NSSF and NSSF’s loan to public agencies. These two items reduce the number by Rs 6.69 lakh crore. The combined effect is Rs 4.36 lakh crore.

Treatment of liabilities is correct at Rs 77.99 lakh crore or 45.62%, but a few missing debt and liabilities remain. For FD, some liabilities have not been included.

FSBs of Rs 9,167 crore & Rs 15,095 crore were issued in FY17 & FY18, respectively. These represent real liabilities. Off-budget FSB liability of Rs 24,262 crore should be included. Annuity for several projects—38 road projects had an FY18 outstanding annuity obligations of Rs 45,689 crore—is incurred by the government.

There are other projects with annuity commitment of Rs 5,050 crore. Thus, total liability obligations were Rs 50,739 crore. FCI received `70,000 crore in FY17 and `65,000 crore in FY18. Out of this, Rs 14,000 crore was repaid in FY18. Rs 1.21 lakh crore was net outstanding as of FY18. Likewise, the Building Materials and Technology Corporation received Rs 8,000 crore for PMAY subsidies. Thus, liabilities of Rs 1.29 lakh crore represented clear obligations.

There is also an element of overstatement. A good part of the external debt represents loans to the states. Although this is rightly included in their budget, for the Centre, it means is double counting. Such liabilities are Rs 1,75,000 crore.

Taking into account the four elements, the total was Rs 78,27,848 crore—higher by Rs 29,000 crore. With a nominal GDP of Rs 170 lakh crore (as per latest advance estimates), Debt/GDP ratio was 45.79%. The debt and liabilities number reported in the FY18 Budget was Rs 82,34, 877 crore. This made up 48.17% of the GDP. However, this does not represent correct description, primarily because of NSSF treatment.

The Status Paper is still not published, but quarterly report on Public Debt Management follows this criteria. As per the report released for the January-March 2019 quarter, total debt and liabilities of the Centre at the end of March 2019 was Rs 84,68,086 crore. This exceeded the liabilities at the end of FY18 by Rs 6,69,238 crore. There seems to be some issue about this number. Special Securities issued by GoI to fund equity infusion in the PSBs is always added in the debt and liabilities. If only the recap bonds of Rs 1.06 lakh crore are added to the provisional FD of Rs 6.45 lakh crore (CGA), the debt and liabilities should be higher by Rs 7.51 lakh crore.

Status Paper for FY19 will clear the matter. At present, it would suffice, if we add the three expenditure, i.e., Rs 2.40 lakh crore to the provisional FD. Increase in debt becomes Rs 8.85 lakh crore. Adding this number to the previous year’s debt and liabilities of Rs 78.28 lakh crore, total debt and liabilities provisionally for the year FY19 stand at Rs 87.13 lakh crore. Total debt and liabilities as per our provisional assessment have increased from Rs 78.28 lakh crore in FY18 to Rs 87.13 lakh crore—from 45.79% to 45.83% of GDP (Rs 190.10 lakh crore).

The real problem
Over the years, borrowings have been increasingly used to fund consumption expenditure and a considerable part of capex incurred is not on creation of productive capital assets. In FY20, the government budgeted a FD of Rs 7,03,760 crore. Budgeted capex is only Rs 3,38,569 crore—48% of the FD. More than half the borrowings, even in terms of budgeting, is meant to be spent on consumption expenditure. Less than half of the borrowings are meant for capex. The actual position is usually worse. In FY18, actual amount spent on capex was 44.5% of the FD. Little more than half the expenditure budgeted as capex is justifiably capex. Therefore, less than 25% of FD is meant for productive economic investment.

The load of government borrowings needs to be reduced in the interest of the economy instead of being relaxed even in the current slowdown. Aggregate deposits in small savings accounts at the end of FY18 were Rs 12.90 lakh crore. These are estimated to be `16.85 lakh crore at the end of FY20. Outstanding amount of all small savings deposits, certificates and accounts as of FY19 was estimated to be Rs 14.81 lakh crore as per Budget FY20 (RE). Small savings outstanding balances are estimated to be growing by about Rs 2 lakh crore every year during last two years.

Savings of people invested in the NSSF are, in a way, assets under management of the government. As AUMs with all MFs were about Rs 25 lakh crore in FY19, AUMs under NSSF at about Rs 15 lakh crore make a significant share of people’s savings.

There are four ‘investment avenues’ for small savings flows—special securities issued by the Centre; special securities issued by State Governments; public enterprises, and authorities of the Government of India; and meeting FD by providing cash balances. In addition, there is liability of the Centre towards accumulated losses in NSSF. The Centre issues three kinds of special securities to NSSF—against Balances lying on March 31, 1999, when the NSSF arrangement came into being; against fresh accumulations in NSSF from April 1, 1999; and against redemption of special securities by the Centre and state governments. At the end of FY18, net investments in these securities was Rs 4,83,919 crore. Outstanding balance of securities issued by states amounted to Rs 5,07,245 crore.

The Centre started making use of NSSF funds to provide loans to central government entities from FY17. The Loans to Public Agencies grew to Rs 1,62,000 crore at the end of FY18.

NSSF pays interest cost on various savings instruments. It also pays a commission charge for managing the small savings portfolio. Interest from the securities issued to both the centre and the state makes up the income of the Fund. In FY18, NSSF’s income was Rs 95,400 crore, whereas its interest expenditure was Rs 91,222 crore and its management expenses Rs 10,822 crore, resulting in Rs 6,643 crore loss.

Government had adopted a policy decision that interest rates payable on different savings instruments would be aligned to the market interest rate on similar instruments, only a small mark up was to be added. Interest rates were to be adjusted every quarter. However, they have been virtually left untouched during the current fiscal, despite policy rates, rates on central government securities and other market instruments coming down significantly. Interest rates on small savings instruments are the highest compared to savings instruments of similar instruments. If tax incentives associated are taken into account, the effective rates are 150-200%.

The government has announced corporate tax cuts and there is considerable shortfall in collection of excise, customs, GST and personal taxes. GoI, however, has not revised borrowing programme, which remains pegged to fund FD of 3.3%. It seems small savings collections are being encouraged, retaining interest rates at higher levels, to fund the higher FD.

In this age of digital banking, there is hardly a need for the government to provide an avenue to park savings. Post offices met this need in 20th century, but are no longer required to.

The government should wind down the system of small savings. Incidentally, no state government (barring 2-3) is now taking small savings. Until the beginning of the first decade, there used to be a clamour to fund state government deficits with small savings. All these are now landing with the centre. These also interrupt transmission. Banks are unable to compete with these rates, but cannot bring down their rates as they would lose out the savings. The small savings system distorts the savings system in the country.

GoI has been raising debt for financing its FD from the market, at market rates, for more than two decades. In 1950s, GoI had decided to issue ad hoc t-bills on RBI, mandating the central bank to fund as much resources as GoI needed by creating money. Rate of interest paid on such ad hoc bills was kept very low. RBI was not generating any meaningful surpluses. In 1990s, this practice was laid to rest. Both agreed that the former will not subscribe to primary issuance of debt and would only operate a limited WMA facility. RBI has dismantled various instruments used earlier to ensure flow of funds to GoI securities—very high SLR being one. The Centre’s G-Secs and that of the States are now issued at price discovered in the market.

A large stock of debt securities has now built, with GoI’s total Debt and Liabilities exceeding 45% of GDP. Large pre-emption of savings and credit created leads to interest rate ruling very high. This has led to the interest expenditure of the Centre to balloon. GoI classifies interest payments in five broad heads—interest on internal debt, interest on external debt, interest on provident funds and other specific accounts in public account, interest on reserves funds and interest on other liabilities. Interest on internal debt constitutes bulk of interest payments now. In FY18, interest on internal debt amounted to Rs 4,87,527 crore—89.71% of total interest paid (Rs 5,43,404 crore). Interest on market loans was Rs 4,04,132 crore (74.37% of total interest paid). Interest on external debt is quite small now as such loans on GoI account are stabilised and will decline going forward. Only an amount of Rs 5,951 crore was paid. As Provident Fund deposits grow at a steady rate, interest payments under this head are also small and growing at a very slow rate. In FY18, it amounted to Rs 33,135 crore, which actually had a negative growth rate of 2.48% over the interest paid under this head in FY17. GoI earns some money usually as premium on the G-Secs issued. Likewise, it also earns some interest on market loans. The finance and accounts state this income on the revenue side, whereas Budget Papers and Analytical Reports display the interest payment net of these incomes. In FY18, such net receipts were about Rs 14,755 crore, which, when netted, made the net interest expenditure to be around Rs 5,28,600 crore.

Interest on other obligations represent the result of by-pass on FD financing attempted by GoI. Interest paid on this head during FY18 was Rs 15,975 crore. The Government has resorted to this route for recapitalising the PSBs and also other financing institutions like EXIM Bank and IIFCL ltd. These bonds were first issued in FY18. The first interest obligations for this came up for payment in FY19. As further bonds were issued in FY19 and FY20 and the amount of bonds issued exceed Rs 2,15,000 crore now, interest payment on these obligations would exceed entire interest payment made during FY18.

Expenditure on interest payments is the largest head of payment and a little less than 25% of total expenditure. About 1/4th of all the resources which the Government of India raises every year, tax, non-tax and debt all taken together, goes only to service interest on the debt and liabilities undertaken by the GoI in previous years. As per the provisional numbers released, in FY19, net interest payments amounted to Rs 5,82,675 crore out of total expenditure of Rs 2,31,1422 crore exceeding 25% of total expenditure at 25.21%. With GoI being in no position to curtail FD and issuance of liabilities outside the Budget also continuing unabated, there is every likelihood that the interest payment in FY20 will also exceed 25%.

Combined expenditure of the Centre on interest payments and establishment was Rs 10,01,983 crore—exceeding 45% of the total expenditure of Rs 21,41,973 crore. Whenever we talk about the ability of the Centre to adjust its expenditure, we must remember that very close to half of all expenditure is simply not in its control. It is the first charge on the revenues and debt raised and has to be so paid.

Headline FD was revised to 3.4% for FY19 (RE) and BE FD for FY20 was first announced at 3.4% in the Interim Budget and later on brought down to 3.3%.

Considering the revenue and expenditure performance in FY20, it is unlikely that headline FD would be anywhere less than 3.5%. Real FD will be much higher.

Given that revenues are unlikely to see any sharp uptick in next FY21 and flexibility to compress expenditure is almost not available, it is almost impossible to keep even the headline FD to 3% for FY21.

Likewise, the debt and liabilities trajectory is moving in reverse direction than the one which was expected while determining the deadline of FY25 for achieving the goal of 40% debt to GDP ratio.

It seems quite likely that the FRBM Act will be amended again to push both the FD goal of 3% to, say FY26, and debt and liabilities goal of 40% to, say, FY31.

It would sound more convincing if this FD goal is defined to include all budgetary and off-budgetary liabilities (which currently are around 4.5% of GDP). A five-year roadmap for brining real FD down from 4.5% of GDP to 3% of GDP is quite reasonable and rigorous. If the government were to disclose and incorporate all its fiscal expenditures into the FD and state the fiscal road map in the budget, the fiscal correction and consolidation would sound more credible. And, if it were to reform the small savings regime and lay down the fiscal consolidation path, it is quite likely that the Debt-to-GDP ratio would also be achieved in this time-frame, most likely even earlier.

Edited excerpts of posts ( & from SC Garg’s blog

The author is Former finance secretary, Government of India

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Source: Financial Express