homeviews NewsBudget 2020: Why govt should not take the off balance sheet route and hide the true picture

Budget 2020: Why govt should not take the off-balance sheet route and hide the true picture

Budget 2020: Why govt should not take the off-balance sheet route and hide the true picture
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By Ashutosh Datar  Feb 1, 2020 7:22:50 AM IST (Updated)

It is better for everyone to know the path the government is going to take so that they can then accordingly incorporate it in their decision making.

The annual budget of the Central government is due today and the usual chatter over which sector will get what allocation or what sectors will see tax breaks or higher tax is in full swing. Another important topic of conversation this year is whether the government will provide a fiscal stimulus to the economy given the weak GDP growth. There are however far bigger issues that this year’s budget ought to deal with than just a tax break here or a higher allocation there. But first, let’s lay down the context for this year’s budget as also for this piece.

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The government started this year, as it has in the last couple of years, with very optimistic revenue projections. Total receipts were projected to grow 25 percent driven by a commensurate growth in tax revenues. But in the first eight months of the year for which we have actual data, overall receipts have grown at just half that pace with tax revenues growing just 3 percent YoY. Tax revenue growth is unlikely to see a materially different trajectory in the remainder of the year since the corporate tax cut has become effective only since October. And despite expenditure growing slower than budgeted (13 percent during April – November as against budgeted growth of 21 percent), fiscal deficit has increased 13 percent YoY in the first eight months of the year as against budgeted growth of just 9 percent. So, for the government to meet its fiscal deficit target, it will need to cut expenditure, not just slow the pace of growth, in the rest of the year.
The real fiscal deficit
And it will need to do so, while economic activity has slowed to multi-year lows. As per CSO’s first advance estimate GDP growth will slow to just 5 percent this year the lowest in over a decade. So, cutting expenditure is the last thing investors or businesses would want from the government. So, given this, if cutting expenditure to meet the deficit target is not a realistic option the government can just abandon the deficit target. Or it can resort to off-balance-sheet activity. Like it has last year. And the year before. By some calculations, the real fiscal deficit is already 100-200bps higher than the reported number.
But before we get into which option the government will choose, we should first appreciate what the Union Budget is. While the Budget is generally associated with new schemes and programmes being announced by the government, at its core the Budget is the government’s statement of account. It lays down the revenues the government has raised and how they were or are likely to be spent (and the extent of borrowings to fund the excess spending over receipts). The revenues for the government come from the citizens of the country in their individual capacity or indirectly when the businesses pay the taxes or fees. The debt the government incurs is also to be paid out of future revenues contributed by the citizens or businesses within the country. Thus, apart from the legal obligation to present the statement of account, there is a moral obligation too to account for how money taken away from citizens and businesses is being spent. The government owes to the people an honest statement of its accounts.
So, when the government takes the off-balance sheet route to manage its finances, it is violating this moral obligation towards the citizens. Because it is then not presenting a true picture of its accounts to the general public. Sure, analysts may eventually figure out the true picture after going through all the documents with a fine comb. But this does not lessen the government’s moral responsibility towards its people. So, the first expectation from the coming budget is that the government stops resorting to off-balance sheet route if the deficit is likely to be higher than what was budgeted. The true state of government finances ought to be reported irrespective of how bad it is. The government owes it to the people.
But there is a deeper reason as to why successive governments in India have resorted to off-balance sheet items (and yes, every government cutting across party lines is guilty). And that reason is that political parties in India do not believe in low deficits as an end in itself. To them, the concept that fiscal deficits should be contained, reduced (and eventually eliminated) is an artificial constraint imposed by technocrats. It does not resonate with them. And hence, while they publicly commit to a deficit target, they are not wedded to it, and the off-balance sheet route is an automatic escape route. And this escape route works when things are good. And as long as it works, they will want to continue with it. So, the real reason why successive governments have resorted to off-balance sheet route to obfuscate the government finances is not their desire to mislead the public but because they do not inherently believe in the concept of low deficits. And the reason the political parties do not care about government deficits is that a large majority of Indians themselves do not care about government deficits. They want the government to spend money to ‘help’ them. So, it is rational for political parties to not care much about government deficits because their voters do not care about them.
Hiding the true picture
So, the next expectation from this budget is for the government to simply admit this. If you do not believe in low deficits as an end, why not be honest about it? Investors or rating agencies might make noise for a few days, but if the going is good (or is expected to be good), their noise will not matter. And if things get bad (or are expected to get bad), hiding large deficits behind off-balance sheet items will not matter.
A related expectation that then follows is for the government to articulate its medium-term fiscal strategy (roadmap). If a 3 percent fiscal deficit is not what the government believes is either achievable or desirable, it should lay down a path that it truly believes is achievable and desirable. This could be 4 percent fiscal deficit or even 5 percent fiscal deficit. Fiscal conservatives like this author might worry about the impact of high deficits on the economy but these consequences cannot be avoided by simply pushing the deficits off-balance sheet. Moreover, it is better for everyone (investors, businesses, analysts and the RBI) to know the path the government is going to take so that they can then accordingly incorporate it in their decision making.
It is here that the answer to the question of whether a fiscal stimulus is possible and if so, what should be the quantum lies. Unfortunately, most people ignore the above discussion and jump directly into the last point of what fiscal deficit the government will budget or how much fiscal stimulus the government will provide. But this misses the point about how off-balance sheet items can paint a very misleading picture of what the fiscal stance really is. For example, hypothetically, if the government were to announce a fiscal stimulus of 1ppt of GDP through a commensurately higher deficit but achieves it by simply shifting off-balance sheet items onto the balance sheet (or reducing the size of off-balance sheet items), then it is not necessarily clear if the fiscal stance is necessarily expansionary.
So, let us hope this year’s budget brings more credibility and honesty to the whole process of preparing the budget from presenting a correct statement of accounts to setting forth a credible path for the next few years and the underlying economic beliefs. Some may call this wishful thinking and perhaps it is but hope floats. To conclude this quote from the great physicist Richard Feynman seems rather apt: “The first principle is that you must not fool yourself and you are the easiest person to fool.”
Ashutosh Datar is the Founder of IndiaDataHub.com, an online platform that brings together all the public data (economic, social, financial) concerning India in a user-friendly analytical app. Before founding IndiaDataHub, he was with IIFL Institutional Equities for over a decade as their Strategist and Economist. Read his columns here.
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