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There is a complete consensus that the source of all the current economic problems lies in the high level of fiscal deficit of the government. After taking charge of the finance ministry the first statement by Prime Minister Manmohan Singh only emphasized the need and resolve to cut the fiscal deficit.

This has been so in India since 1991. This “Delhi view" has now moved beyond the confines of policymaking and has afflicted Mumbai’s economic doers. In addition to an old convert, the Reserve Bank of India (RBI), now market movers—analysts, fund managers, brokers and traders—too endorse this view. In other words, the primacy of fiscal deficit reduction is now the market and private sector view as well.

In this process of transmission what was primarily a diagnostic analysis has now become a prescriptive matter irrespective of the dynamics of the deficit and/or the investment profile of the economy.

The simple point that now cuts across all lines is that excessive government borrowing sets into motion a chain of events that crowd out productive private investment directly in terms of fund availability or indirectly by pushing up the rate of interest. Indeed, in a rare sign of autonomy, RBI has virtually put reduction of fiscal deficit as a precondition for interest rate cuts.

A key basis for these analytical constructs is that government borrowings are used to finance revenue expenditure. In budgetary terms, an increasing part of the fiscal deficit comprises revenue deficit vis-a-vis capital expenditure (the two together go to make up the fiscal deficit). As such, with no capacity being created, the vicious circle of debt, deficits and inflation is triggered.

More importantly, the argument is that it crowds out private sector’s “productive investment". It stops at this. If one were to go beyond this level and look at the borrowings and investment patters of the private corporate sector, this argument weakens considerably.

Given the size and significance of the private sector in the investment landscape, should the “fiscal deficit" and its associated set of arguments apply to the private sector as well? In other words, isn’t the “fiscal deficit of the private sector" important for the overall economy? Most analysts tend to view the borrowing question of companies as a problem of individual over-leveraging. In addition, insufficient attention is paid to the utilization of these borrowings.

Last year, 2011-2012, the total capital expenditure of private sector, estimated at 2,61,00 crore, was less than its borrowing of 3.15 trillion from just one source—commercial banks and financial institutions. If the borrowings from other sources are added, the gap is much wider and rises by almost one-third. Total corporate debt now accounts for 88% of the funding, twice of what it was in 2007-08.

This exceptional situation has arisen as in the last three years the rate of growth of borrowing has been consistently higher than the rate of growth of capital expenditure of the private sector.

It follows that borrowings are being used to finance current expenditures and not capital expenditures. It also suggests that a negligible level of equity and retained earnings are being used to finance new investments. This in turn is a pointer to the adverse incremental debt to equity ratio which is rapidly impairing the once healthy average debt equity ratio of this sector.

From the data on aggregate borrowings of the corporate sector, it seems clear that it is the level of borrowings more than the cost of these borrowings that is the source of the distress in the private sector. This is aggravated by the fact that these borrowing are not being used for capacity creation or even utilization.

How is this situation any different from the one that prevails in the government? The government is also borrowing excessively to finance current expenditures, so is the private sector.

After the ending of the automatic monetization of the budget deficit, the overall macroeconomic impact of the two investments—by the government and the private sector—are not radically different. Both these deficits are now being funded from the same pool of financial resources. Which then begs the question as to why the “fiscal deficit" of the corporate sector is not being seen as a reason for the slowdown in growth or the rise in inflation?

It also seems evident that in the case of the private sector, debt is not only a problem of slow growth. As such, the resolution of problem doesn’t lie only on reviving growth but also in ensuring that there is a proper plan for deleveraging and reducing the absolute level of debt in the private sector as a whole.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com

Also Read |Haseeb A. Drabu’s earlier columns

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