What should we make of the recent budget? The honest answer is we cannot really assess it until well into next year. Yes, not until 2021. The reason becomes evident when answering two key questions: What are the broad aims of the government’s budget policy? What are the realities?
After more than five years in power, it is becoming clear that the government has three key objectives, captured in Figure 1. The first is to advance the Prime Minister’s vision of New Welfarism. This comprises the public provision of essential private goods and services via various government schemes: toilets, cooking gas, bank accounts, rural housing, power, targeted transfers to farmers, medical emergency insurance, and now water.
It is difficult to attribute and hence quantify precisely the amounts associated with the new schemes but a ballpark number would be somewhere between Rs 1.5 – 2.5 trillion in 2019-20, around 1 per cent of GDP.
And because these schemes have essentially supplemented existing programmes, rather than replacing them, overall government expenditure has also increased by around 1 percentage point, to at least 14 per cent of GDP
Even as the government has been launching spending schemes, it has been determined to establish a reputation as fiscally conservative. It—quite rightly—wants to be seen as a responsible and trustworthy guardian of taxpayers’ money, after years of indiscipline and waste. Accordingly, its budget announcements have consistently targeted an improvement in the fiscal deficit.
The government has also ensured that ex post headline deficits remain close to 3.5 per cent of GDP
and certainly less than 4 per cent of GDP, the number that this government inherited from its predecessor. This is the Figure 1.)
The third objective is that bond markets must not be rattled. Accordingly, the government has ensured that the magnitude of market borrowing is kept on the safe side of a threshold, beyond which markets could be spooked, causing interest rates to spike. As Figure 1 shows, market borrowings have been kept in the range of 2-2.5 per cent of GDP, well below even the fiscal deficit
targets. Bond markets still rule.
From objectives, turn next to the realities. Especially since 2017-18, reality has not cooperated with the government’s plans. In particular, despite determined efforts to improve tax collections so as to finance the new spending, net tax revenues to the centre have stagnated at about 7.25 per cent of GDP. Even gross tax revenues have only improved marginally, hovering between 10.5 and 11 per cent of GDP, while non-petroleum related taxes (which excludes the windfall from lower global oil prices since 2014-15) have remained flat at 9.5 per cent of GDP. In this light, the decision in 2019 to raise income tax thresholds to Rs 5 lakhs—thereby narrowing the base from 60 million to just 15 million taxpayers—seems a retrograde policy move, as T N Ninan
Stagnating tax revenues have posed an acute dilemma, for without additional resources and given the Fourteenth Finance Commission’s huge devolution increase to the states, how can the three objectives be met? The answer has been the “50 ways” strategy. Paul Simon (of Simon and Garfunkel) has sung that “there must be 50 ways to leave your lover.” Similarly, the government has found many means—policy and accounting—to meet budgetary objectives.
On policy, the government has conserved revenue for itself in many ways: by shifting taxation to cesses that are not part of the divisible pool shared with the states; deferring payments of IGST that were due to states (in 2017-18); and not paying the 14 per cent GST compensation due to states (2019-20).
On accounting, a growing share of public sector activities has been shifted off budget. Public enterprises have been asked to finance their own capital expenditure. Subsidy payments have been scaled back, forcing FCI to step up its borrowing from the NSSF. And even some of the new welfare schemes are being financed in part through novel off-budget mechanisms such as “fully serviced bonds.” It is important to mention that off-budget financing was extensively used in 2007-08 and 2008-09 by the UPA government in the form of oil and fertilizer bonds.
Taking these “50 ways” into account, “true” deficits (official deficits plus extra budgetary financing of expenditures) are now 4.6 per cent of GDP and could be as high as 5 percent of GDP if agencies such as NHAI are included. This level is higher than: the official deficit of 3.8 per cent, the FRBM target, and what the government inherited. A broader Public Sector Borrowing Requirement (PSBR) indicator that includes the financing of the central public sector enterprises (mentioned in statement 25 of the Budget) is close to 9.5 per cent of GDP, having increased by about 1.5-2 percentage points since the government came to power.
Three important conclusions follow. First, the divorce of budgetary objectives and reality has had a serious impact on budgetary integrity. The government deserves considerable credit in this budget for acknowledging the problem by listing off-budget expenditures in an annex. It should continue in this direction until the red and the black lines in Figure 3 become one. Indeed, transparency and integrity would get a real boost if next year’s budget included a similar table on the government’s major arrears to the public and private sectors.
Why is integrity important? The answer is that the “50 ways” strategy has real costs. Some of these arise from the distortions created to finance the true deficits, such as high interest rates (to keep the NSSF flush with funds), financial repression (issuing non-marketable—“fully serviced”—bonds held by public sector entities), and complexity (NHAI issuing bonds whose interest is financed by the budget). The cost of NSSF borrowing is not just the higher interest rates but the revenue foregone because these saving instruments are tax exempt.
At the same time, the associated lack of transparency and the over-optimistic revenue projections create uncertainty in the economy, especially toward the end of the fiscal year. Financial markets can’t be sure how much the government is really going to borrow, taxpayers can’t be sure how aggressively collectors will pursue their targets, spending ministries don’t know whether they will really be able to spend the funds initially allocated in the budget. Policymakers and analysts have problems assessing whether the fiscal stance is providing stimulus to the economy--or withdrawing it. The truth is that for the last few years, fiscal policy can only reliably be known well after the fiscal year is over! All of this uncertainty impairs decision-making, thereby impeding economic recovery.
Second, while headline deficits have improved, the actual fiscal position has deteriorated. The change is not huge—and deficits on average are still much lower than in the 2009-2014 period—but the change is steady and in a worrying direction (and we don’t really know the states’ true fiscal situation). Already, the debt-GDP ratio has begun to creep up. If growth remains weak, the fiscal situation will become another source of risk and vulnerability. In other words, the growth crisis of today could turn into a serious fiscal problem tomorrow if current trends are not reversed. And, of course, the first step to solving a problem is recognizing transparently that the problem exists.
Third, in principle, this fiscal drift should be contained by the FRBM framework. But the framework is clearly broken. It is not just that the 3 percent of GDP deficit target has repeatedly—across many different governments—been honored only in the breach. It is also that the “50 ways” strategy has eviscerated the official targets of meaning, and unless that is corrected the framework cannot serve its intended purpose.
In the interim, the onus for keeping the debate tethered to reality will lie with outside participants—financial market analysts, think tanks, ratings agencies, international institutions, and academics. Will they be industrious and honest, showing the reality as their baseline numbers rather than as an after-thought? Or will they continue their complicity in perpetuating the spell that headline fiscal numbers—like headline numbers in other areas—always seem to cast?
To paraphrase the famous saying, “Fool us once, shame on you; fool us often, shame on us.”