Bridging the fiscal gap: The capriciousness continues

How do you manage your house? I mean, how well do you balance your expenses against your income? Doesn’t this sound like a very basic question? Sure, it is. The answer to the question should also be fairly simple. Experience andwisdom suggest that you should always tread cautiously, not allowing your expenses to override your income. This is the first step to managing your overall finances prudently.

Having established and agreed upon this basic fact of life, let’s go a step further. How do you create long-term assets, say buying a house, or for that matter, even a car? The recent trend, particularly in today’s liberalised economic world, is that you would get it funded through a loan. Well, that is fine too, provided you can build the repayment of the loan comfortably into your income.

Now, consider a scenario where your expenses suddenly start exceeding your income. First of all, this situation should ring alarm bells for you as to why you are spending more than what you are earning. And if the situation gets any worse, what would your course of action be to correct it? Any rational person would think of ways to enhance their income so as to meet the additional burden of expenditure, or consider cutting down some part of the expenses so as to strike a balance between income and expenses. How many people would actually go out and decide to liquidate the assets created out of their hard-earned money in order to fund their spending binges? Not too many, we think. Would you even think of selling off your house to bridge the deficit? Where would you stay if you did that?

The reason why we are looking at this situation so closely is because today, the Indian government is out to do something very similar and completely irrational to take care of its deficits, rather than trying to mend its ways of unmindful spending. Let’s take a look at how the situation described above is paralleled by what the government is up to.

The RBI Governor, D Subbarao, recently made a statement as part of an address at the International Research Conference. Subbarao said, “There is an inflexion point beyond which fiscal deficits militate against growth. Government borrowing is not bad per se, but excessive borrowing is. There is, therefore, a need to cap total public debt as a proportion of GDP”. He further stated, “If the government borrows and squanders that money away on unproductive current expenditure, both fiscal sustainability and growth would be jeopardised”.

There have been very few instances when the Governor of the central bank has been so vocal about the government’s role in the deteriorating fiscal balance of the country. The reason behind such vehement outrage is not hard to understand. In the first nine months of FY12, the fiscal deficit has already reached 92.3 per cent of the budget estimates, and is at Rs 3.8 lakh crore against the entire year’s budget estimate of Rs 4.12 lakh crore. The situation is worse in case of the revenue deficit (93.1 per cent of budget estimates) and primary deficit (139.2 per cent). If we look at the average for the last few years, the fiscal deficit for the first nine months of the year has been around 64.3 per cent. So, what could be the reason for the severe deterioration in the condition of government finances?

An analysis of government finances for the nine months ending December 2011 shows that there has been a substantial increase in expenditure, which stands at 13.9 per cent compared to the budget estimate of 3.4 per cent (overshooting by more than 10 per cent!). The revenue expenditure, which does not add to the production capacity of the nation and is expended in salaries, interest rates, etc., has gone up by 12 per cent on a YoY basis. Although capital expenditure has increased by 29 per cent, it still accounts for only 12 per cent of the total expenditure in absolute terms.

If we look at the long-term trend of capital expenditure with respect to the total expenditure, it has been worsening. Capital expenditure, which used to account for more than 40 per cent of the total expenditure in the 1970s, has gradually come down to the lower teens in the last seven years. At the same time, revenue expenditure has increased from 57 per cent to 87 per cent currently. What this means is that the government is now paying more and more to meet its day-to-day needs, rather than creating infrastructure that will help in generating income in the times to come. Some of these revenue expenses directly or indirectly help to fuel inflation – MNREGA and food subsidies for instance. (You can read more about how wasteful the MNREGA scheme has resulted to be in a subsequent article). In the current volatile times, when the private sector is slowing its expenditure in building capital assets, the government should come forward and increase capital expenditure. However, we are observing the exactly opposite situation.

Snapshot of Public Finances

Now that we have seen how the government expenses have fared, let’s take a look at the revenue side. In the first nine months of FY12, the revenues were down by 16.3 per cent on a YoY basis against an increase of 3.6 per cent anticipated in the budget estimates. Clearly, slowing economic activity has  taken a toll on revenue collections. The net tax revenues are up by a mere 7.5 per cent compared to budget estimates of 18 per cent. If we dig deeper to know which part of the tax revenues were the worst performers, corporate tax and excise top the list. Corporate tax has gone up by just six per cent while excise increased by 8.1 per cent against the budget estimates of 21.5 per cent and 19.2 per cent respectively. The rest of the revenue heads like income tax and custom duties remained in line with the estimates. Better performance on the service tax front greatly helped in minimising the fall, growing by 37.3 per cent compared to the budget estimates of 18.2 per cent. However, the non-tax revenues seriously impacted the government revenues, down by 60 per cent a YoY basis. The reason for such a fall is the absence of onetime receipts that we witnessed last year in the form of 3G license fees.

Looking at the rising expenditure and the deceleration in revenue growth, we believe that the government will not be able to contain the fiscal deficit to the budget estimates of Rs 4.128 lakh crore. In fact, it is likely to overshoot this estimate by at least 100 basis points of GDP, which works out to nearly Rs 1 lakh crore. There are very few avenues and precious little time left for the government to cover up the gap.

One of the measures that it is mulling is the buyback of shares, under which it can raise money by selling equity held by government companies to the PSUs themselves. Many cash rich companies like Coal India, NMDC, ONGC, etc. are on the government’s radar for this purpose. In addition to this, other measures could involve floating a new special purpose vehicle to pledge shares owned by the Specified Undertaking of the Unit Trust of India (SUUTI) and using the funds to buy stakes in PSUs. SUUTI came into existence after the restructuring of the erstwhile Unit Trust of India (UTI), and holds stakes in Axis Bank (23.6 per cent), ITC (11.5 per cent) and L&T (8.3 per cent). The current worth of this stake is Rs 35500 crore.

Regardless of whatever measures that the government takes to bridge the budget deficit, we believe that these will bring only temporary respite. Moreover, these measures effectively mean that the government is trying to sell the assets that took a long time to build up, to fund its largesse. If we have to sum up the current status of the government in managing the country’s finance, it is like selling your jewels to fund grandiose and lavish functions.

Surely, the government should learn some lessons from what is happening in other parts of the world, especially Europe, which is facing one of the worst sovereign debt crises thanks to their governments’ inability to understand the meaning of fiscal prudence. Therefore, the Indian government should expedite bringing in of the lapsed Fiscal Responsibility and Budget Management (FRBM) Bill, and should strictly stick to the targets. Short-term pain will definitely help the country to reap long-term benefits.