By Nikhil Gupta
Union Budget 2020 India: With the arrival of the new year, the season of Union Budget expectations has also begun. As the economy dovetailed into multi-year slowest growth, there is obviously no dearth of suggestions. It is also not surprising that most of these recommendations boil down to one thing-relaxing fiscal deficit target. "The sky is not going to fall, if fiscal deficit is 4% of GDP this year" is the usual argument made almost unanimously. The government must explicitly spend Rs 2 trillion (about 1% of GDP) on infrastructure investment, and expand the deficit by the same proportion. Not only will this lead to much-required investment spending in the economy, it may also crowd-in private investments. Needless to say, the markets would also cheer this. This argument is totally faulty, because not only true investments of the central government are already almost double of the reported numbers, but the adjusted fiscal deficit is also much higher than 4% of GDP. Additional borrowings are, therefore, likely to tighten financial markets further.
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Let us consider this. One of the major responsibilities of the government is to provide basic food subsidy to poor people of the country, which is primarily achieved through the Food Corporation of India (FCI). Monthly data suggest that food subsidy was a negative Rs 237 billion in March 2017, negative Rs 882 billion in March 2018, and negative Rs 805 billion in March 2019. How can subsidy be negative? Did the government take back the subsidy amount from the poor people? Obviously not. What happened in the last three years was that the government implemented a part of its food subsidy programme by asking the FCI to borrow on its books, which created off-budget borrowings. The FCI actually paid back a portion of these borrowings to the central government so that the reported deficit target could be maintained. However, total borrowings of the public sector, including borrowings by such many central public sector enterprises (CPSEs), were much higher than the reported borrowings. As of end-March 2019, our estimates suggest that there were outstanding arrears amounting to Rs 2.6 trillion (or 1.3% of GDP) on account of food, fuel and fertiliser subsidy.
Similarly, there are many other CPSEs such as the National Highways Authority of India (NHAI) and the Indian Railway Finance Corporation (IRFC) that have borrowed off-the-budget and invested. Although the Budget reports total capital spending of the central government was Rs3 trillion or 1.6% of GDP in FY19, almost a similar amount of capital spending was being borrowed and invested by these CPSEs. The adjusted capital spending of the central government, thus, was at least Rs6 trillion, or 3.2% of GDP.
All this suggests that the adjusted fiscal deficit of the central government was 6.3% of GDP-almost double the reported 3.4% in the Union Budget. Further, while the budgeted deficit was 3.5% of GDP two years ago in FY17, the adjusted deficit has risen sharply by 1.5 percentage point of GDP (from 4.8% of GDP) in past two years. Include state governments and we find public sector deficit has risen from 7.6% of GDP in FY17 to 8.8% of GDP last year.
So what if fiscal deficit is about 9% of GDP? Let's take it to 10% because the economy is so weak-some could argue. However, if you compare public sector deficit with household financial savings in the country, the ratio stands above 130%-the highest in at least the past two decades. This, we believe, is a prominent reason why bond yields are at so elevated levels notwithstanding such weak growth.
Overall, the government's actual spending-which is what matters for the economy-is much more than the reported numbers. Consequently, the deficit is already much higher than the reported 3.4% of GDP. It also suggests that if CPSEs have become so important, then the Budget numbers are increasingly losing their relevance.
Our only expectation from Budget FY21, therefore, is to bring back the relevance of budgeted numbers by introducing public sector borrowing requirement (PSBR), which informs not only about the planned borrowings of the central government, but also includes (net) borrowings of CPSEs. Shifting away from cash to accrual-based accounting would help streamline this change.
The author is chief economist, Motilal Oswal Financial Services