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    The two worrying trends in this year’s interim budget

    The two worrying trends in this year’s interim budget

    The two worrying trends in this year’s interim budget
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    By Ashutosh Datar   IST (Updated)


    Governments in India have not shown their commitment to fiscal prudence or fiscal consolidation, as a matter of principle.

    The NDA government presented its 5th and final budget (of this term at least) on February 2, 2019.
    While the general focus in any budget remains on things like income tax exemptions, the fiscal deficit targets or new schemes or benefits etc., there are two worrying trends in this budget. Although, these worries are not new, the budget only continues with these trends. It is also not the case that these trends are unique to the current government. And this is what makes it all the more worrying. Irrespective of which party is in power, we are likely to get the same or even more of these, rather than less. The two key worrying trends are more entitlements without any thought to funding and fuzzy accounting.
    The path of entitlements without funding
    The UPA government started India’s move down the path of entitlements with the National Rural Employment Guarantee Act or the NREGA and the Food Security Act. The current NDA government continued that path with a very broad medical insurance scheme (covering 40 percent of Indian families) announced in last year’s budget. And this has continued in the current budget with the direct income transfer of Rs 6,000 per agricultural household. Given the growing talk about universal basic income, it appears that a broader income guarantee scheme of some kind will be in place in the next year or two irrespective of which party is in power.
    Now, these entitlements are not a problem by themselves. It is hard to argue against a proposal that gives people right to have two modest meals a day or health insurance to protect them from medical emergencies. The problem is that it is easy for governments to announce entitlements without their long-term funding plan. The two schemes announced by the current government will cost around 0.6 percent of GDP when fully rolled out. This is a big amount especially when the medium-term objective is to reduce the fiscal deficit by 50 basis points. Even the food subsidy expense has increased ahead of nominal GDP in the last five years – during a period of low food inflation. So, even the past entitlements have not plateaued.
    The question is, how these current and future entitlements are going to be funded? There are two ways – the first and the most-easiest is through more taxation. And tax rates have gone up in the last few years. The marginal tax rate for individuals, which was 30 percent, has gradually crept up to almost 36 percent for ‘rich’ individuals. It can go even higher. The second way to fund these entitlements is to cut back on other ‘well-intentioned’ schemes which have failed to achieve their purpose. This is the most logical way of implementing these entitlements. The various interventions in agriculture, such as fertiliser subsidy or MSP have not worked, so let us do a Direct Benefit Transfer (DBT) to ensure it reaches the intended beneficiary and remove the erstwhile interventions (aka distortions).
    However, the nature of our politics is such that the second option is almost impossible to implement. For taking away benefits, even if they have not served their purpose, is almost unthinkable politically. And it is not just the politicians to blame here. For politicians are simply responding to their incentives as they see them. The problem is, a vast majority of Indians see the government as the solution to problems rather than being the problem itself. Rather than wanting the government to gradually recede in the background (in an economic and business sense) which would have been the expectation if the government is perceived to be the problem.
    Form over Substance
    One of the most basic principles of accounting is ‘substance over form’ and unfortunately, successive governments in recent past seem to be focused more on form than substance. This is reflected in their focus on meeting or coming close to the numerical fiscal deficit target, without considering how that is achieved. Consider the following:
    • The Government made the RBI pay an interim dividend of Rs 10,000 crore last year. This effectively tantamount to the front ending of income since the RBI has never paid an interim dividend before in the last several years. But then, revenues need to grow on a year on year basis. So, implicit in this year’s budget is an interim dividend of Rs 30,000 crore– so even more ‘upfronting’ of income. The interim dividend, if paid this year, will be more than 50 percent of the total dividend paid by the RBI for its last year. And perhaps, in the next year, to ensure that revenues (dividends) grow, an even higher portion of RBI’s profits will be upfronted through dividends. And then one year, the RBI will stop paying a final dividend since the entire profits will have been paid through the interim dividend.
    • Take the example of disinvestments. The process of disinvestment started during the last NDA government with actual privatisation of public sector units. This subsequently evolved into selling small stakes in public sector units to investors through a public issue. It then became a process where the government was selling stakes in public sector units to another government-owned company such as the LIC. And last year this process touched a new low with one public sector company buying another public sector company. And this ‘strategic’ disinvestment will likely get repeated this year with the proposed PFC-REC transaction.
    • There is also a growing reliance on off-balance sheet methods to show a lower deficit. In FY18, for instance, the government made investments of over Rs 1 lakh crore (Rs 92,000 crore net of repayments) in public agencies such as the Food Corporation of India or NHAI or the IRFC from the National Small Savings Fund. In the current year, as per the revised estimates, this number has increased by 40 percent to Rs 1,60,000 crore (Rs 1,20,000 crore net of repayments). By bypassing the general budget, this effectively under-states the total government expenditure and fiscal deficit by this amount.
    • Consider another example on the expenditure side. In the revised estimate of last year’s budget, the food subsidy bill for FY18 was pegged at Rs 1,40,000 crore. The actual food subsidy bill for FY18 (in terms of cash paid) was almost 30 percent lower. The revised estimate was released in the budget presented on 1st February last year, just two months before the end of the year. Presumably, the estimate was made based on data available till December or early January. The only logical way to explain how an estimate can be so dramatically off is by presuming that the government put off the payments to the subsequent year.
    • Of course, this is not something unique to this government. The previous government also used dodgy methods to numerically achieve its fiscal deficit – ranging from issuing off-budget bonds to in lieu of subsidies or varying the share and timing of subsidy payments to public sector entities depending on the fiscal health of the government or even to withhold tax refunds to meet the revenue targets. Even the deterioration in the quality of disinvestment is not something unique to the current government. What this means basically is that the fiscal deficit number has started to lose its relevance. It no longer reflects the reality of government finances. The fiscal deficit number reported in the last several years, cutting across governments, has been consistently close to the target, consistently close to what the market and analysts estimate it to be.
      The bigger take away is that successive governments in India, irrespective of which political party is in power, have not shown their commitment to fiscal prudence or fiscal consolidation, as a matter of principle. They believe in it only because, it is something they are told financial markets and analysts and rating agencies bother about. They will, thus, only deliver on fiscal prudence and fiscal consolidation only to the extent that satisfies these entities. For now, these sets of entities are focused largely on the numbers ignoring the quality of fiscal consolidation or the way the numbers are attained. But that might not continue forever. The government should not take the market and market participants for granted.
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