Why credibility of India’s fiscal math is under strain

Mumbai: The Narendra Modi-led National Democratic Alliance (NDA) government has been lauded for its ability to rein in the headline fiscal deficit over the past few years, which has arguably helped tame inflation. However, with reverses in key assembly elections earlier this month and Lok Sabha elections to be held in just a few months, the urge to splurge has never been as intense as it is today.

As a Plain Facts column had pointed out a few months ago, India has witnessed fiscal slippages in seven of the past 11 elections.

What is more worrying is the growing attempts at window-dressing, which could strain the credibility of India’s fiscal math and impose a heavy burden on future generations and future governments.

This year, the government is contemplating not paying for a part of fuel subsidies to avoid making the fiscal deficit number look bad, Mint reported on Monday. This comes on top of a big unpaid food subsidy bill, owed to the Food Corporation of India (FCI), which keeps getting deferred every year.

The practice of “rolling over” subsidy payments to the FCI was not started by this government. However, the problem has become worse under this government, as a December 2017 report from the Comptroller and Auditor General (CAG) has abundantly made clear.

According to another CAG report, the government also owed about ₹ 25,000 crore to states as of 2015-16, as the Centre’s devolution to the states out of the government’s gross collection of taxes and duties, as per 14th Finance Commission guidelines, fell short by that much during the year.

That’s not all. The reliance on extra-budgetary resources (EBR)—such as funds of state-owned enterprises—to fund ambitious programmes of the government could add to fiscal risks.

For instance, 61.4% of all capital expenditure outlined in the 2018-19 budget is slated to be financed through EBR, up from 54% in 2016-17.

Similarly, 84% of the announced spending on agriculture and rural livelihoods is slated to be financed outside the budget, the fine print shows.

If we take into account such excesses, India’s fiscal consolidation begins to appear far less impressive than what the headline numbers suggest.

The NDA government was blessed with an oil price bonanza in its early years, which allowed it to raise fuel taxes without much public backlash.

Almost the entire consolidation of public finances can be attributed to this bonanza, as an earlier Plain Facts column had shown.

The reversal in oil prices in the latter part of the government’s term has ended this revenue channel, forcing the government to resort to extraordinary methods to try and fund the shortfall in the fiscal deficit.

Such “creative” accounting has led to a decline in the headline fiscal deficit number but failed to bring down India’s public debt to GDP (gross domestic product) ratio, as the former chief economic adviser to the finance ministry, Arvind Subramanian, points out in his recently published book, Of Counsel.

India’s Debt-GDP ratio has remained elevated at around 70% (one of the highest among large emerging markets) over the past four years despite a rising nominal GDP.

“Firms must report their results according to established accounting principles,” Subramanian wrote. “But things are different when it comes to government. Singer-songwriter Paul Simon once told us that there are 50 ways to leave a lover. Similarly, governments have more than 50 ways—policies and accounting—to meet a deficit target. The narrower the definition of government, the greater the scope for shifting things off-budget.

The more complicated the fiscal arrangements, as they are in India because of different layers of ‘off-budget’ activities and incurring of contingent liabilities, the more the scope for creative accounting.”

The financing of budgetary expenditures through the National Small Savings Fund (NSSF) is one of the problem areas, which does not reflect in real-time deficit numbers but involves higher borrowing costs for the government over the long-term and shows up in interest payment numbers.

Such borrowings have climbed dramatically over the past few years.

The deficit financed through the National Small Savings Fund in 2017-18 was almost 50% higher than the previous year. This year, the government is likely to finance about ₹ 75,000 crore of its fiscal deficit from National Small Savings Fund, according to budget projections.

The use of the Life Insurance Corporation (LIC) and State Bank of India (SBI) to bail out weaker state-owned firms also runs the risk of adding to debt (and deficit) numbers over the long run, Subramanian argues.

“The LIC and the SBI are playing a quasi-government role in helping distressed public-sector and private sector enterprises such as Infrastructure Leasing & Financial Services,” Arvind Subramanian writes.

“For the moment, these activities will not show up in the government accounts. But ultimately they may do so, for if the bailouts lead to losses, the government may need to step in to assume some of the debt that Life Insurance Corporation and State Bank of India have thereby incurred.”

Data sourced from Prime Database shows that LIC has become the lifeline for the government’s divestment programme, helping inflate stake sale proceeds at the expense of the unsuspecting LIC policy holder.

The big jump in the government’s divestment proceeds is in large measure thanks to the largesse of the country’s biggest life insurer.

In other cases, the government has relied on deals such as between Oil and Natural Gas Corp Ltd (ONGC) and Hindustan Petroleum Corp. Ltd (HPCL) and REC Ltd and Power Finance Corporation (PFC) to fund its own coffers without any material change in management in any of the companies. Even the central bank’s coffers have not escaped attention of finance ministry mandarins, sparking a conflict with the Reserve Bank of India.

Unless the math behind India’s fiscal deficit gets as much attention as the headline fiscal deficit number, such creative accounting is likely to get worse.

With elections around the corner, expect more such creative proposals in the coming weeks and months.